October 2000

Flexible Benefits

  • Flexible benefit plans are programs in which an employer provides plan participants with a variety of options and group benefits, between group and nongroup benefits, and in the case of a cafeteria plan, between cash and benefits. A flexible benefits plan allows a benefits program to be designed to meet the personal needs of plan participants (within the allowable limits under the Internal Revenue Code, or IRC.)
  • IRC Sec. 125, created by the Revenue Act of 1978, formally introduced a subset of tax-qualified flexible benefit plans commonly known as “cafeteria plans.” These plans offer employees a choice between at least one qualified (nontaxable) benefit and one taxable benefit (including cash). Sec. 125 allows employers to provide employees with a choice among benefits without requiring them to include the value of the benefits in their adjusted gross income unless they choose taxable options.
  • There are three types of tax-qualified plans under IRC Sec. 125: premium conversion plans (which allow workers to contribute health care premiums on a pretax basis), flexible spending accounts (FSAs, which allow workers to pay for uncovered medical or dependent care expenses on a pretax basis), and cafeteria plans (which allow workers to choose among a variety of benefits up to the maximum amount of credits or dollars they are allotted). According to the Bureau of Labor Statistics (BLS), in 1997, 52 percent of full-time employees in medium and large private establishments participated in a Sec. 125 plan.
    • Premium Conversion Plans--These plans may exist either within a cafeteria plan or separately. If an employer health care plan requires an employee premium contribution, premium conversion allows employees to make their contribution with pretax dollars. According to the BLS, 7 percent of full-time employees in medium and large private establishments participated in a stand-alone premium conversion plan in 1997.
    • Flexible Spending Accounts--FSAs may exist as a stand-alone plan or within a cafeteria plan. Employees choose how much money they want to contribute to an FSA at the beginning of the plan year. To the extent that these funds are not used during the plan year, they are forfeited. There are two types of FSAs: health care and dependent care. Employers may offer employees one or both types, but the money contributed to each must be treated separately. Contributions to a dependent care FSA are limited by law to no more than $5,000 annually. There are no legal limits on contributions to a health care FSA, but a plan sponsor may set a limit. Allocation of unused portions of an FSA is at the plan sponsor's discretion. By law, the only action a plan sponsor may not take is returning the unused portion to the employee. The employee forfeits any claim to the unused portion. According to the BLS, 32 percent of full-time employees in medium and large private establishments participated in a stand-alone FSA in 1997.
    • Cafeteria Plans--In general, cafeteria plans must offer a combination of two or more benefits consisting of cash and qualified nontaxable benefits (such as health insurance). Although the tax code specifically refers to cash, a taxable benefit (such as vacation pay) is generally viewed as the equivalent of cash. In addition, elective contributions from Sec. 401(k) plans are treated as nontaxable benefits under cafeteria plans. Under a cafeteria plan, the participant must forfeit the unused benefits at the end of the year, with the exception of any compensation deferrals under IRC Sec. 401(k). According to the BLS, 13 percent of full-time employees in medium and large private establishments participated in a cafeteria plan in 1997.
  • In 1999, among employers with 10 or more employees, 12 percent offered a cafeteria benefit plan, 15 percent offered a stand-alone health care FSA, and 15 percent offered a stand-alone dependent care FSA. By 2001, an additional 1 percent of employers with 10 or more employees expect to offer a cafeteria benefit plan, an additional 1 percent expect to offer a stand-alone health care FSA, and an additional 1 percent expect to offer a stand-alone dependent care FSA.
  • In 1999, the average contribution to a health care FSA was $838, and the average contribution to a dependent care FSA was $2,717.
  • An employee making $30,000 a year, who contributed to a medical care FSA (in the average amount of $838), would see a net tax savings of $184.
  • An employer that offers a health care FSA can gain a net tax saving of $1,346. This figure is based on an employer with 100 employees, with an average salary of $30,000 per employee, in which 21 percent of employees participate in the health care FSA, each contributing the average amount of $838.

For more information, contact Ken McDonnell, (202) 775-6342, or see EBRI's Web site at www.ebri.org.

Source: EBRI Databook on Employee Benefits, fourth edition, 1997.

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