A Section 125 plan—also known as a cafeteria plan—is a benefits structure defined in the U.S. tax code that allows employees to pay for certain qualified expenses with pre-tax dollars.
For employers, this means reduced payroll tax liability. For employees, it means paying less in federal income tax, Social Security, and Medicare—without reducing take-home pay or cutting benefits.
The IRS recognizes Section 125 plans as tax-qualified, provided they meet specific documentation, eligibility, and nondiscrimination testing requirements.
Introduced in 1978 through amendments to the Internal Revenue Code (IRC) to encourage more flexible employee benefits.
Found in Section 125 of the IRC, hence the name.
Designed to provide a “menu” of benefit options—like a cafeteria—so employees can select the ones that best meet their needs.
Updated over time to integrate with laws like:
“The IRS recognizes Section 125 plans as tax-qualified, provided they meet specific documentation, eligibility, and nondiscrimination testing requirements.”
Your provider drafts the Plan Document and Summary Plan Description (SPD), outlining the benefits offered and eligibility criteria.
Employees elect benefits during open enrollment or when eligible due to life events.
Employee contributions toward eligible benefits are deducted before taxes—reducing taxable wages.
Lower taxable payroll means reduced FICA taxes (Social Security and Medicare)—typically 7.65% savings for every pre-tax dollar.
The provider conducts nondiscrimination testing, updates documents, and ensures ongoing compliance with IRS, ACA, ERISA, and HIPAA rules.
Let’s break it down in plain numbers:
Multiply that across years—and larger employee counts—and the savings can be substantial.
If an employee earns $60,000/year and contributes $4,000 pre-tax to benefits, their taxable income drops to $56,000. This reduces income and payroll taxes—saving them hundreds annually.
If your workforce collectively contributes $500,000 pre-tax, you save approximately $38,250 in FICA taxes (at 7.65%).
(medical, dental, vision)
(up to $50,000 in coverage)
IRS-compliant wellness and preventive benefits, often at zero net cost to employer or employee.
🪴 Plan Type
📝 Description
🎉 Common Use Case
Allows employees to pay their share of insurance premiums pre-tax.
Businesses with existing group health insurance.
Offers multiple pre-tax benefit options.
Mid-to-large companies looking to give employees flexibility.
Pre-tax accounts for healthcare and/or dependent care expenses.
Companies with employees who have predictable medical or childcare costs.
Pre-tax wellness benefits, screenings, and preventive care.
Employers wanting to enhance health offerings without raising costs.
🪴 Plan Type
📝 Description
🎉 Common Use Case
Allows employees to pay their share of insurance premiums pre-tax.
Businesses with existing group health insurance.
Offers multiple pre-tax benefit options.
Mid-to-large companies looking to give employees flexibility.
Pre-tax accounts for healthcare and/or dependent care expenses.
Companies with employees who have predictable medical or childcare costs.
Pre-tax wellness benefits, screenings, and preventive care.
Employers wanting to enhance health offerings without raising costs.
Section 125 plans must comply with multiple regulatory frameworks:
IRS — Plan documents, eligible benefits, and annual nondiscrimination testing.
ACA — Affordability and minimum essential coverage requirements for health benefits.
HIPAA — Safeguarding medical information and ensuring portability.
ERISA — Governs reporting, disclosure, and fiduciary duties for certain benefits.
Good news: A reputable provider will handle the majority of compliance tasks, including document updates, payroll integration, and annual testing.
$600–$1,200+ in annual payroll tax savings per W-2 employee.
More competitive benefits without increasing costs.
Reduced turnover through better employee satisfaction.
Minimal administrative burden—your provider handles 85%+ of the work.
For a CEO, CFO, or VP of Finance, Section 125 plans are more than an HR perk—they’re a financial efficiency tool. By leveraging pre-tax structures, companies can free up budget for growth, bonuses, or reinvestment while boosting employee benefits.
