Merritt Personal Lines Manual: Chapter 2 Cafeteria Plans
Congress first authorized so-called "cafeteria plans" in 1978, as part of the Internal Revenue Code (Section 125).
The term "cafeteria" refers to the way in which the insured can spend proceeds from the account -- on any specific needs which may arise, like choosing dishes in a cafeteria line. Since we're talking about health coverage, this is an unfortunate image. Cafeteria plans are also known as "flexible-spending accounts" and "Section 125 plans."
Any company can set up a cafeteria plan for its employees. This allows the employees to pay for a full menu of medically oriented expenses with pre-tax dollars. This not only reduces taxable income for employees -- making the benefits virtually free -- it also reduces taxable payroll for the employer.
The insured can use the money from a cafeteria plan to pay for various deductible expenses. These can include:
- health insurance premiums,
- unreimbursed medical expenses (including co-payments for doctor visits or prescription drugs),
- dependent care expenses,
- alternative medical treatments (including acupuncture and chiropractic),
- treatment of alcoholism,
- programs to lose weight or quit smoking,
- vision care (eye doctor visits, glasses, contacts, etc.),
- birth control pills (which some health plans do not ordinarily cover),
- special schooling and care for people with disabilities (from wheelchairs and crutches to artificial limbs and Braille books),
- dental fees, dentures and orthodontia,
- psychiatric care and
- hearing aids.
If the insured's employer offers a cafeteria plan, the insured choose the amount the insured would like to have withheld from each paycheck. If the insured typically spend $200 a month on child care and another $50 on prescription co-payments, for example, the insured might elect to have $250 a month withheld from the insured's paycheck. If the insured also have annual expenses for glasses, co-payments for checkups, dental visits and so on, the insured can have an additional amount deducted each month to cover these costs, as well.
This money is placed into an escrow account. Whenever the insured have a medical cost that is not covered by the insured's insurance, the insured submit a claim to the company that manages the insured's employer's cafeteria plan and that firm debits the insured's account and sends the insured a check.
A cafeteria plan can be a very good way to save money on health care costs. However, the key is to avoid having too much money deducted from the insured's paychecks. Whatever money the insured put into a cafeteria plan each year must be used for health care costs. If there is money left over, it cannot be rolled over into the account for the next year or returned to the insured. As far as the he or she concerned, it's gone.
The chart below illustrates why you might want to pay for medical expenses you already have with pre-tax dollars.
The Benefits of Using a Cafeteria Plan
Without a Cafeteria Plan
Gross Salary -- $1,600.00
Federal & State Taxes -- 221.82
Social Security (FICA) -- 122.40
Less Medical Premium -- 110.60
Less Medical Expenses -- 60.00
Less Dependent Care -- 200.00
Spendable Income -- 885.18
With a Cafeteria Plan
Gross Salary -- 1,600.00
Federal & State Taxes -- 135.43
Social Security (FICA) -- 94.05
Less Medical Premium -- 110.60
Less Medical Expenses -- 60.00
Less Dependent Care -- 200.00
Spendable Income -- 999.92
Source: Cynthia Pogue Baker, CPA
