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May 15, 2024 Matt Venuto

Do I Need a Section 125 POP Plan and Documentation? Understanding the Pros and Cons

Do I Need a Section 125 POP Plan and Documentation? Understanding the Pros and Cons

As a small business owner, you're always looking for ways to save money, provide competitive benefits, and better serve your employees. Implementing a Section 125 plan can help you achieve these goals, but it's crucial to understand the difference between the plan itself and the documentation required to support it.

You might wonder, "What's the difference between a Section 125 plan and its documentation, and why do they both matter?" Many small business owners know the benefits of a Section 125 plan but may not realize the importance of properly documenting it to ensure compliance and protect their business.

In this blog post, we'll dive into both! We'll explore the key components of a well-designed section 125 plan and what you must include in your section 125 POP plan document. 

We'll also discuss the advantages of having a solid plan and proper documentation and the potential risks of neglecting either aspect. By the end, you'll understand how a Section 125 plan and its documentation work together to benefit your business and your employees.

Section 125 POP Plan Documents Vs. The Plan Itself: Understanding the Differences

A Section 125 Premium Only Plan (POP) is an employee benefit plan that allows your staff to choose from a wide range of pretax benefits when it comes to healthcare premiums. Cafeteria plans allow employees to allocate insurance premiums and other funds on a pretax basis to pay for qualifying health insurance expenses and premiums. 

Participating in a Section 125 Plan allows your team to save between 20% and 40% in combined federal, state, and local taxes on items they usually already purchase with out-of-pocket, post-tax funds. 

The exact amount of savings depends on the employee's location, and there are usually savings for the employer as well. If your employees opt into the plan, you’ll experience pretax saving too by paying less in payroll taxes.

A Section 125 Premium Only Plan (POP) document is the legal document that outlines the terms and conditions of your Section 125 Plan, specifically focusing on the premium-only aspect. This document is essential for employers who want to offer their employees the opportunity to pay for their health insurance premiums on a pretax basis.

Here is a breakdown of the key components your Section 125 POP plan document should include:

1. Plan description: A detailed explanation of how the plan works, including who is eligible, how to enroll, and what benefits are covered.

2. Contribution and benefits information: Details on how much your employees can contribute, how the contributions are taken from their pay, and how the funds can be used to pay for health insurance.

3. Election procedures and deadlines: Information on when and how your team can enroll in the plan, change their elections, or stop participating.

4. Legal compliance: A statement ensuring that your section 125 POP plan complies with all applicable federal and state laws.

  • Non discrimination testing and additional tests to maintain compliance
5. Plan sponsor responsibilities: An outline of your responsibilities as an employer in running the plan, like keeping records, communicating with your team, and making sure everything is legal.

Having a well-drafted Section 125 POP Plan Document helps you as an employer. It ensures your POP plan complies with legal requirements, protects your business from potential disputes or legal challenges, and clearly communicates the plan's terms to your team.

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Now that you understand the plan and how a section 125 POP plan document can help you build and run it well, will you choose to offer one to your team? First, let’s explore some pros and cons to help you make that choice.

Pros and Cons of Section 125 Plans

Pros of Section 125 Plans 

  1. Your Employees Get More Tax Savings
    A Section 125 plan offers many advantages for you and your employees. One of the biggest ones is the potential for employees to save more on taxes. By contributing to the plan with pretax dollars, your team can reduce their taxable income and potentially lower their income tax bracket. This increases their take-home pay compared to making contributions with after-tax dollars.
  2. Your Team Can Customize Their Benefits (and get better, more flexible ones, too)
    Another advantage of Section 125 plans is their flexibility. During open enrollment periods, employees can choose the benefits that best suit their needs, adjust their benefit selections, or allocate funds based on their requirements. Pretax contributions also make these benefits more affordable for employees.

    As an employer, you can tailor your plan to fit your company’s specific needs and budget, including other benefits like health insurance, life insurance, disability insurance, and more. Nondiscrimination testing makes sure that your plan remains compliant and that employees receive fair benefits based on their pay.
  3. You’re Not Locked Into Income Restrictions
    Unlike some tax-advantaged plans, Section 125 plans do not have income restrictions for participation. This means that employees at all income levels can take advantage of the plan's benefits, making it an accessible option for a wide range of workers.
  4. You Can Potentially Save on Healthcare Expenses
    Lastly, Section 125 plans can help employees save on healthcare expenses. By contributing pretax dollars to FSAs or HSAs, they can save money on eligible healthcare expenses and make more informed decisions about their healthcare spending.

Potential Cons of Section 125 Plans 

Just as there are advantages to Section 125 plans, there are potential downsides, too. 

1. Employees Must Use Or Lose FSA Funds
One potential drawback of Section 125 plans is the "use it or lose it" provision for. Employees must use their contributed funds within the plan year or risk forfeiting any unused money. This can lead to employees overestimating their expenses or making unnecessary purchases to avoid losing funds at the end of the year.

  • If you have additional funding to roll over, you can opt to roll these funds over to an HSA instead. 

2. You Can’t Always Make Mid-Year Changes

Another limitation of Section 125 plans is the restriction on mid-year changes. Employees can typically only change their benefit selections during open enrollment or when a qualifying life event happens, like turning 26, getting married, or having a child. If an employee's needs change unexpectedly outside of these specified times, they might not be able to adjust their plan.

Do I Need a Section 125 Plan and POP Plan Document?: Asked and Answered 

A Section 125 Plan can provide valuable tax benefits and flexible spending options to your employees, depending on your business's goals and employee benefits strategy. The Section 125 POP plan document sets you up to do this well and communicates it clearly to your workforce.

We don’t offer Section 125 plans or health insurance plans here at ConnectPay, but we can help you find trusted, local brokers to explore your options. Or if you’ve already got a Section 125 Plan but need a Plan Document–we can help too! Our new product Connect Section 125 is an affordable vehicle to master Section 125 Plan Document compliance for your small business! Our portal and its tools can help you manage Section 125 compliance all year long. 

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Published by Matt Venuto May 15, 2024