IRS 125 Plan (Cafeteria Plan)

An IRS 125 Plan, also known as a Cafeteria Plan, is an employee benefit plan that allows employees to choose from a selection of pre-tax benefits. These benefits can include health insurance, dental insurance, vision insurance, flexible spending accounts (FSAs), and other fringe benefits. Here are some key features of an IRS 125 Plan:

• Pre-tax contributions: One of the main features of an IRS 125 Plan is that employees can make pre-tax contributions to their selected benefits. This means that their contributions are deducted from their paycheck before taxes are calculated, which can result in significant tax savings.

• Flexibility: An IRS 125 Plan allows employees to choose from a range of benefits and contribution levels based on their individual needs. Employees can select the benefits that are most important to them and adjust their contribution levels accordingly.

• Limited enrollment period: Employees typically have a limited enrollment period during which they can choose their benefits for the upcoming plan year. After the enrollment period ends, changes to benefit elections may be limited or restricted until the next enrollment period.

• Use-it-or-lose-it rule: Some IRS 125 Plans may have a "use-it-or-lose-it" rule for certain benefits, such as FSAs. This means that if employees do not use the funds in their FSA by the end of the plan year, they will forfeit the remaining balance.

Example: ABC Company offers an IRS 125 Plan to its employees. The plan includes a range of benefits, such as health insurance, dental insurance, and an FSA for medical expenses. Employees can choose the benefits that best fit their needs and budget, and make pre-tax contributions to those benefits.

John, an employee at ABC Company, elects to participate in the plan and chooses a high-deductible health insurance plan, a dental plan, and contributes $2,000 to his FSA for medical expenses. By making pre-tax contributions, John saves money on taxes and has access to affordable health and dental insurance, as well as pre-tax funds to pay for qualified medical expenses.

At the end of the plan year, John has $500 remaining in his FSA. Because ABC Company's plan has a "use-it-or-lose-it" rule, John must use the remaining funds by the end of the year or forfeit the balance. He schedules a dental cleaning and uses the remaining FSA funds to cover the cost.