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What is a Section 125 Plan?
A Section 125 Plan is a tax savings employee benefit plan that was created by Congress and written into the Internal Revenue Code in 1978 (IRC Section 125). A Section 125 Plan allows participating employees to direct a portion of their salary to be used to pay for approved expenses. Approved expenses can be the employee's part of the group insurance premium or other expenses such as medical copayments, deductibles, or dependent daycare. The portion of the employee's salary directed into the Plan is done so on a pre-tax basis. The taxes saved by the participating employees are federal income tax, state income tax, and FICA (Social Security and Medicare) tax. Due to the nature of the plan, all companies offering a Section 125 Plan must file the appropriate documentation with the IRS. Annual filings may be necessary depending on the company. Dedicated, professional administration is also required as some information processed may contain sensitive medical information. This is why companies looking to expand their benefit package should turn to MDSIS-Spring for assistance with Section 125 Plan implementation.
The two most popular kinds of Section 125 Plans offered through MDSIS-Spring, are Premium-only plans (POP) and Flexible Spending Accounts (FSAs). (See definition of POP and FSA below.)
What is a Premium-Only Plan (POP) plan?
This is the most basic Section 125 Plan option. Employees can pay for their share of the medical insurance premium using pre-tax dollars, thereby lowering their taxable income and potentially saving them a significant amount of money. The taxes saved by the participating employee are federal income tax, state income tax, and FICA (Social Security and Medicare) tax. This generally results in a total tax savings of approximately 28.5% on the portion of the salary used to pay for medical insurance premiums. The taxes saved for the company are the matching portion of the FICA tax and FUTA tax (Federal Unemployment Tax). This results in a savings for the employer of 7.65% for each employee enrolled in the plan.
What is a Flexible Spending Account (FSA)?
This popular Section 125 option is similar to the POP plan concept. Spending accounts are a means for participating employees to pay for approved out-of-pocket health care or dependent care costs on a pre-tax basis. There are two types of spending accounts that can be established: Health Care Reimbursement Accounts and Dependent Care Reimbursement Accounts.
Participating employees establish and fund Health Care Reimbursement Accounts with pre-tax dollars from their salary. Employees have the opportunity to decide how much money they want in their account and then they elect whether or not to have this money deducted from their salary. When the employee incurs approved healthcare expenses they are able to withdraw money from their Health Care Reimbursement Account to cover the expenses. The benefit of the Health Care Reimbursement Account is that funds are not taxed when they are withdrawn, thus giving the employee tax-free money to pay for approved expenses.
Dependent Care Reimbursement Accounts are established in a similar fashion. Employees have the opportunity to decide how much money they want in their account and then they elect whether or not to have this money deducted from their salary on a pre-tax basis. When the employee incurs approved dependent care expenses they are able to withdraw money from their Dependent Care Reimbursement Account to cover the expenses. The benefit of the Dependent Care Reimbursement Account is that funds are not taxed when withdrawn, thus giving the employee tax-free money to pay for approved expenses. Unlike the Health Care Reimbursement Account, the Dependent Care Reimbursement Account has an annual maximum reimbursement limit of $5,000 or $2,500 if a couple is married and filing taxes separately.
What are some examples of reimbursable healthcare expenses?
Approved health care expenses include but are not limited to:
- acupuncture
- medical co-payments
- dental expenses
- laser eye surgery
- smoking cessation programs
- contacts and cleaning solutions
- orthodontia
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- chiropractor fees
- medical deductibles
- durable medical equipment
- learning disability care
- eyeglasses
- lab fees
- hearing aids and batteries
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What are some examples of reimbursable dependent care expenses?
Approved dependent care expenses include the following:
- preschool fees
- babysitter fees
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- daycare fees
- after school program fees
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In order for dependent care expenses to be considered eligible, the dependent children in question must be age 12 or younger and live at the participating employee's home for at least eight hours a day. Other considerations may apply depending on the expense.
How do I figure out how much to take out annually for my FSA?
Participating employees should calculate their annual out-of-pocket cost for approved healthcare or dependent care expenses. Once an appropriate amount has been determined, employees make an election to have pre-tax deductions made from their salary. Deductions are made evenly from each paycheck, not annually in one lump sum. Employees should not be too liberal in their elections as money not withdrawn from spending accounts is forfeited at the end of the plan year and given back to the employer to offset administration costs. Adjustments to spending account elections can only be made during the plan anniversary or if the participating employee has a qualifying event such as marriage or birth of a child.
Back to FAQs | Section 125 and Health Savings Account Plan Administration Products Page
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