Group Insurance Benefits - Section 125 Plans

What are Section 125 Plans?

One type of group insurance benefits that may be offered by an employer are Section 125 Plans. These Section 125 Plans are also known as cafeteria plans, flexible benefit plans or mini-flex plans. The Internal Revenue Code Section 125 outlining these plans first appeared in the tax code in 1978, but didn't gain popularity until tax laws changed in 1986 and gave employees greater tax advantages.

The purpose of the code was to allow employers to have a separate written plan for their employees that provided them with an opportunity to receive certain fringe benefits on a pretax basis. All plans are strictly regulated by the IRS and must meet specific requirements and regulations that can and do change. The written plan must specifically describe all benefits and establish rules for eligibility and elections. Because of the stringent guidelines, many employers offering these plans have them administrated by an outside source.

How do Flexible Benefit Plans Work?

Each payroll through a deduction from their paycheck, the participant contributes money to a Spending Account. This money is not taxed. The participant is then reimbursed from this account by their employer (or outside Administrator) for those health care expenses not covered under a health insurance policy or by a health care provider.

The participant's expenses are reimbursed in full up to the maximum amount of their annual election at the time the claim is submitted. The expenses must be incurred during the plan year while they are covered by the plan. Any funds left in the Spending Account at the end of the plan year will be lost.

These plans run for a year at a time. At the beginning of the plan year, the participant chooses how much they are going to contribute - called the annual election. A participant can have two Spending Accounts; one for themselves (called the Health Care Account) and one for their dependents (called the Dependent Care Account). The Health Care Account and the Dependent Care Account are treated separately and so funds from one account cannot be transferred to the other account.

In deciding what the annual election should be, a participant should look at their health insurance deductibles and copayments, as well as uninsured medical, dental, vision care and hearing care expenses. The uninsured expenses covered must be "medically necessary" as determined by a doctor or healthcare service provider.

You may see some generalized expense categories listed when people talk about what expenses are covered. These may include things like:

> Non-reimbursed medical expenses resulting from charges due to hospital, physician, dental, orthodontia, vision, and prescription drug expenses incurred.

> Deductibles and copayments resulting from charges due to hospital, physician, dental, orthodontia, vision, and prescription drug expenses incurred.

> Rehabilitation services over a long-term period to include drug and alcohol addiction.

> Health care expenses that meet medical expense requirements for federal income tax purposes.

There is actually a lot more to the eligible expenses. Please see the detailed list at the end of this article for this year's eligible expenses.

Why are Flexible Benefit Plans Good?

From the employer's point of view, you are offering your employees an added benefit and helping them to save money on their taxes.

From an employee's point of view, you save taxes and you pay for health care expenses not covered under a health insurance policy or by a health care provider with money that has been set aside for you through payroll deductions. Thus, when these expenses come due, you don't have to pay for them from your daily cash flow.

Without a 125 Plan, you have no pre-tax deductions for premiums, child/dependent care or other out-of-pocket medical expenses.

So say you made $26,000 a year. Without the pre-tax deductions allowed by a 125 Plan, you would be taxed on the full $26,000. At a Federal Income Tax Rate 15%, a State Income Tax Rate of 3% and a Social Security Tax of 7.65%, you would be taxed a total of $6,669.00 on your income of $26,000 if you didn't have a 125 Plan.

If you had a 125 Plan and paid $1,000 for premiums, $5,000 for child/dependent care and $500 for out-of-pocket medical expenses for a total of $6,500 you would be taxed on $19,500 instead of the full $26,000.

At the same tax rates mentioned above, you would be taxed a total of $5,002.00 if you did have a 125 Plan.

And don't forget without a 125 Plan that you would still have those premium, child/dependent care or other out-of-pocket medical expenses of $6,500 to pay.

So what does that all mean to your net take-home pay?

Without the 125 Plan:

$26,000 = $12,831

With the 125 Plan:

$26,000 = $14,498

By participating in a 125 Plan, you would bring home an extra $1,667.

Finally, as promised, here is a list of this year's eligible expenses:

Acupuncture

Alcoholism treatment

Ambulance service

Artificial limbs

Artificial teeth

Body Scan

Braces

Birth control pills

Braille books and magazines

Car expenses for the installation of special hand controls or other special equipment for the use of a person with a disability

Chiropractor

Christian Science Practitioner

Contact lenses, solutions and insurance

Coinsurance

Corrective surgery to improve a deformity arising from or directly related to a congenital abnormality, a personal injury resulting from an accident or trauma or a disfiguring disease

Crutches

Deductibles

Dental fees

Drug and alcohol addiction treatment

Eye exams

Eyeglasses

Eye Surgery when performed to correct visual acuity; (example: laser vision correction)

Guide dog or other animal trained to assist persons with physical disabilities

Hair transplants as a result of a medical condition

Hearing devices and batteries

HMO copayments

Home improvement or special equipment installed in the home for the main purpose of medical care

Hospital bills

Immunizations

Inpatient confinement for mental or physical illness or injury

Insulin and glucose testing equipment and supplies

Laboratory fees

Lead-based paint removal from walls to prevent lead poisoning

Lifetime care fee for medical care only in a retirement home

Lodging expenses when primarily for and essential to medical care

Medical doctor fees

Medical information plan

Medical supplies prescribed for treatment of a medical condition

Medicines prescribed by a medical doctor, osteopath, dentist, chiropractor and/or optometrist

Mentally handicapped persons' cost of special home

Nurses fees

Nursing home medical care fees

Obstetrical expenses

Operations

Orthodontia

Orthopedic shoes

Osteopath

Over-the-counter medications such as allergy medicines, pain relievers and cold medicines, etc.

Oxygen

Podiatrist

Prescriptions (see Medicines)

Prosthesis

Psychiatrist

Psychologist

Smoking cessation program participation and prescribed medication only

Special schools and education for a mentally or physically impaired person

Special telephone and television equipment for a hearing-impaired person

Surgical fees

Therapy treatments for a medical condition

Transplant expenses including payments for surgical, hospital, laboratory and transportation expenses for a donor or a possible donor of a kidney or other organ

Transportation expenses primarily for and essential to medical care

Tuition at a special school for the handicapped

Walker

Weight loss program if prescribed by a physician (excluding the cost of food and/or supplements)

Well-baby and well-child examinations

Wheelchair

Wigs required as a result of a medical condition

X-rays

You should also be aware of the ineligible expenses:

Cosmetic surgery and dental expenses incurred for the general improvement of appearance including face-lifts, hair transplants, hair removal (electrolysis), liposuction, teeth whitening (bleaching)

Custodial care in an institution

Funeral expenses

Health club dues, fitness centers, YMCA membership, spas, massages, etc. for general health improvement

Household and domestic help

Illegal operations, treatment or drugs

Insurance premiums for Life, Accident and Long Term Care coverage

Maternity clothes, diaper service, etc.

Over-the-counter medications, herbs, vitamins and nutritional supplements purchased for overall good health.

Rogaine, unless prescribed for the treatment of high blood pressure

Social activities such as dance lessons or classes (even though recommended by a physician for general health improvement)

Special school for a problem child for anticipated benefits child may receive from the course of study and disciplinary methods

Uniforms

Section 125 Plans are definitely a good benefit for employers to offer their employees and a good benefit for those employees to take advantage of.