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May 31, 2024 Erin Crowley

How Section 125 Cafeteria Plans Work with an HSA or FSA

How Section 125 Cafeteria Plans Work with an HSA or FSA

How Section 125 Cafeteria Plans Work with an HSA or FSA

As a business owner, you know that offering a strong benefits package is essential for attracting and keeping the best employees. That's where Section 125 cafeteria plans come in. 

Your employees get to pick and choose from a menu of options, like health insurance, and pay for them with pretax dollars. It's like giving them a raise without actually increasing their salary! But the benefits don't stop there. By partnering a Section 125 cafeteria plan with an HSA or FSA, you can help your employees save even more on healthcare expenses and keep more of their payroll in their pockets. And when your team is happy and healthy, that means better productivity and a stronger bottom line for your business.

In this article, we'll dive deeper into Section 125 cafeteria plan HSAs and FSAs, exploring how they work together, and the key benefits they can offer your organization.

Is a Section 125 Cafeteria Plan With HSA or FSA the Way to Go? 

A Section 125 cafeteria plan HSA or FSA can be an excellent choice for many employers and employees due to its flexibility and tax-saving advantages. Employees can allocate a portion of their salary toward their HSA before taxes are deducted, reducing their taxable income and increasing their take-home pay.

Before deciding whether a Section 125 Plan is the best option, it’s essential to carefully consider your organization's needs, budget, and workforce demographics. Additionally, Section 125 Plans require proper documentation to stay compliant with federal and state regulations, so it’s wise to consult an expert before exploring and moving forward with either of these options.

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What is a Section 125 Plan? 

Before diving into how section 125 cafeteria plan HSA works, it’s important to understand the plans themselves. A Section 125 cafeteria plan lets employees choose how much of their salary goes towards specific benefits before taxes are deducted. This includes benefits like health insurance premiums, dependent care, or flexible spending accounts.

The plan works by allowing employees to contribute a portion of their gross income to an account before taxes are calculated. This account can be a Health Savings Account (HSA) or another designated account.

The term "cafeteria" is used because employees can customize their benefits packages more flexibly. They can choose the benefits that best suit their individual needs.

For your employees, key benefits include:

  1. Lower taxable income: Employees allocate some of their income to their HSA before taxes are deducted, reducing their taxable income.
  2. Higher take-home pay: The lower taxable income allows employees to keep more of their earnings while enjoying valuable healthcare benefits.
  3. Financial and savings opportunities: Investing in an HSA through a Section 125 cafeteria plan can contribute to long-term financial stability, allowing employees to grow their balances over time.

You get benefits as an employer, too, including:

  1. Reduced payroll taxes: Employers can also benefit from tax savings since employees' pretax contributions to their HSAs reduce taxable payroll.
  2. Lower employment costs: These tax savings can help employers manage their budgets more effectively.
  3. Employee wellbeing: A Section 125 cafeteria plan with an HSA can contribute to happier, healthier, and more productive employees by offering benefits that support physical and mental well-being.

What is the difference between an HSA and an FSA? 

What is an HSA? Great question! A Health Savings Account (HSA) is a tax-advantaged account that lets you and your employees make tax-free contributions to pay for certain out-of-pocket medical expenses. A Flexible Spending Account (FSA) is another type of tax-advantaged account that can be included in a Section 125 cafeteria plan. 

There are two types of FSAs: 

  1. Health FSA: This type of account pays for eligible medical expenses not covered by an employee's health insurance plan, such as deductibles, copayments, and prescriptions.
  2. Dependent Care FSA: Employees can use this account to pay for eligible dependent care expenses, such as daycare, preschool, or elder care, which allow them to work or look for work.

Like an HSA, an FSA lets employees set aside a portion of their earnings to pay for qualified expenses before taxes are calculated, reducing their taxable income. 

There are also some key differences between HSAs and FSAs, including:

  • FSAs are owned by the employer, while HSAs are owned by the individual employee.
  • Generally, FSA funds must be used within the plan year or grace period, or the employee loses the money. On the other hand, HSA funds roll over from year to year.
  • Employees cannot take their FSA with them if they change jobs or leave the workforce, while HSAs are portable.
  • To be eligible for an HSA, an employee must be enrolled in a High Deductible Health Plan (HDHP). FSAs do not have this requirement.

How Section 125 Plans Work with an HSA or FSA

As an employer, you may want to create a Section 125 plan to offer benefits like health insurance, HSAs, and FSAs to your employees. During the annual enrollment period, employees can choose to participate in the plan and elect to contribute a portion of their salary to either an HSA or FSA. 

These elected amounts are deducted from your employee's paycheck before taxes are calculated, reducing their taxable income–resulting in a higher net pay. The pretax contributions are then deposited into the employee's HSA or FSA, which they can use to pay for their healthcare expenses. This arrangement results in tax savings for you and your team: employees save on income taxes and payroll taxes, while you save on payroll taxes for the amounts contributed to HSAs and FSAs.

Section 125 Plan Eligibility and Ownership:

A Section 125 plan is typically created by the employer, offering benefits to employees, their spouses, and dependents. While former employees may have access, the plan cannot primarily exist for them. This distinction in ownership and eligibility ensures that the benefits are structured to support current employees and their families.

Unused FSA Funds Won’t Carry Over Next Year:

The 'use-it-or-lose-it' rule applies to any remaining FSA funds at the end of the year. These funds will be forfeited. 

Maximize Employee Benefits with a Section 125 Cafeteria Plan HSA or FSA 

To provide your employees with the best benefits, use both Section 125 plans and Health HSAs or FSAs together. You will also save on your share of payroll taxes for the pretax amounts taken, which will likely offset the costs of setting up the plan.

We don’t offer Section 125 plans or health insurance 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 Erin Crowley May 31, 2024