Academic journal article Journal of Business and Entrepreneurship

Cafeteria Plans: Saving Employers and Employees Money

Academic journal article Journal of Business and Entrepreneurship

Cafeteria Plans: Saving Employers and Employees Money

Article excerpt

ABSTRACT

A Cafeteria Plan gives employees the opportunity to select from a wide menu of qualified fringe benefits and to pay for these benefits with "tax-free" dollars. It offers several benefits to both employer and employees, including lower tax bills and, for the employer, a method of cost containment in the area of fringe benefits. However, some risks are entailed for both the employee and the employer. As these benefits can be significant, it is anticipated that more and more firms will take the risks and will establish Cafeteria Plans during the 1990s.

INTRODUCTION

How can a business give its employees a raise, increase its profits, and not incur any outof-pocket expense? Simple, adopt the provisions contained in Section 125 of the Internal Revenue Code. Section 125 first and foremost offers choice, and ifs because of this characteristic that the terms "Cafeteria Plan" and "Flexible Benefit Plan" are used to describe this benefit. Cafeteria Plans are not an employee benefit per se, but a delivery system for existing benefits.

In the workplace, however, Cafeteria Plans have become synonymous with certain insurance products now available. But they go beyond insurance; they offer employees certain fringe benefits paid for with tax-free dollars. Cafeteria Plans offer employees choices; they give employees the opportunity to select from a wide menu of qualified fringe benefits. Once established by a company under the guidelines of Section 125, a Cafeteria Plan allows eligible employees to redirect part of their salary to pay for fringe benefits selected from the menu. The amount of this redirected salary is exempt from taxation.

Cafeteria Plans are in place at nearly a quarter of the nation's top 500 corporations, and their use is expected to double in the next five years (Clark, 1990). As the nature of the American workforce has changed, the needs of the American worker have changed as well. The workforce has evolved from a stable, primarily male population with fairly uniform needs to a population that is more mobile and contains more women and early retirees; therefore, the needs of today's workforce are very different and diverse. As a result of these changes in demographics and in the needs of the workforce, employees are now demanding that employers provide a wide choice of benefits. Under these conditions, many experts in the field believe that Cafeteria Plans will be the accepted mechanism for delivering fringe benefits during the 1990s.

Two main reasons exist for establishing a Cafeteria Plan within a particular company-the employees save money, and the employer saves money. Savings occur for both because every dollar of salary redirected to the plan lowers the employee's as well as the employer's tax bills, including income and Social security taxes. Employers may also reduce the cost of worker's compensation insurance, unemployment tax, and in some cases, retirement plan contributions (Thompson, 1991).

HOW THE CAFETERIA PLAN WORKS

A Cafeteria Plan works through premium conversion and reimbursement accounts. It starts when the employee signs an agreement to reduce his/her salary in addition to insurance premiums and selects specific benefits from the menu. Under this agreement, the employee voluntarily elects to redirect a portion of his/her salary which the employer deposits into a plan reimbursement account for the expressed purpose of paying for the selected benefits.

When the employee incurs expenses, the Cafeteria Plan reimburses him/her to the extinction of the salary reduction. Therefore, the company acts somewhat as a bank in which the employer makes deposits of the redirected portion of salary and the employee makes withdrawals from the employee's individual reimbursement account. There is no statutory dollar limit on medical reimbursement accounts, although employees should evaluate their own situation before setting the dollar amount. …

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