What is a cafeteria plan?

A cafeteria plan is a certain kind of employee benefit plan where employers offer their employees a number of different pre-tax benefit options from which they may choose. This is sometimes also referred to as a flexible benefits plan. With a cafeteria plan, employees contribute a certain amount of pre-tax income in exchange for accessing certain combinations of benefits, such as life insurance, health insurance, and disability insurance, they can then access at this pre-tax rate. 

How does a cafeteria plan work?

Cafeteria plans allow employees to use pre-tax dollars to select from a number of employer-offered benefits. These benefits often include things like a health savings accounts (HSAs), group life insurance, disability insurance, and flexible spending accounts (FSAs). They may even include things like adoption assistance benefits or cash benefits. 

What are the advantages of a cafeteria plan?

A cafeteria plan allows an employee to tailor their benefits to how they best feel they need them at a given life stage. For example, an employee may choose where to put their pre-tax dollars to maximize those dollars for their families’ needs, selecting a robust health plan at a time when they need to be accessing lots of health care services for their family, or spending less on health insurance but more on 401k matching at times when that makes more sense for them. 

Because of the way it utilizes pre-tax dollars, a cafeteria plan also reduces a given employee’s amount of taxable income for a given tax year. 

What are the disadvantages of a cafeteria plan?

One important factor to keep in mind is that an employee must determine how much from their pre-tax salary to contribute to cafeteria plan benefits before the beginning of the new tax year. And any pre-tax dollars not spent on cafeteria benefits in a given tax year are forfeited if not used. For example, if someone decides to contribute $3000 to a HSA for a given year, but ends up only having $2000 in health care costs, then they will have lost $1000 pre-tax dollars. 

Also important to keep in mind is if an employee opts for any kind of taxable benefit like cash, then will be liable for that benefit on their annual income taxes. 

Because of their complexity, a cafeteria plan is more burdensome and difficult for an employer to manage, even though it can have financial benefits for an employer because of the use of an employee’s own pre-tax dollars.