In Colorado’s competitive labor market, offering a compelling benefits package must be a top priority for business owners.
This includes health insurance and various voluntary benefits like disability, critical illness, dental, and vision plans. Other benefits include pet insurance, legal assistance plans, and supplemental options tailored to employee needs.
In most cases, the best way to offer supplemental benefits is through a Section 125 cafeteria plan.
These plans provide a strategic way for you to provide your employees with the benefits they value most—while saving both your employees and your business thousands of dollars in payroll taxes.
This blog is a comprehensive guide on how a Section 125 plan works, its benefits, and how to set it up effectively in Colorado.
Learn More: The Comprehensive Colorado Small Business Health Insurance Guide
What is a Section 125 Cafeteria Plan?
A Section 125 Cafeteria Plan is a benefits arrangement that allows employees to choose from various pre-tax benefit options.
Named after Section 125 of the Internal Revenue Code, this plan allows employees to choose from various benefits. These include health insurance, flexible spending accounts (FSAs), health savings accounts (HSAs), and dependent care assistance.
Since employees pay for these benefits with pre-tax dollars, their taxable income decreases—resulting in payroll tax savings for you, the employer. This advantage helps you and your team by allowing more money to stay in everyone’s pocket.
FREE QUOTE
COLORADO HEALTH INSURANCE
Types of Benefits Offered Under a Section 125 Plan
A Section 125 plan can offer a range of benefits that employees can fund through pre-tax payroll deductions, including:
- Health Insurance Premiums – Allowing employees to pay their share of health insurance premiums with pre-tax dollars is a major benefit that can help with budgeting and reduce taxable income.
- Health Savings Accounts (HSAs) – When paired with high-deductible health plans (HDHPs), HSAs provide a powerful savings tool. HSAs are popular among employees who want to save for future medical expenses while enjoying tax advantages.
- Flexible Spending Accounts (FSAs) – FSAs offer an additional way for employees to save on medical expenses, like copays, prescriptions, or even dependent care expenses, using pre-tax dollars.
- Dependent Care Assistance – Providing pre-tax options for dependent care expenses can be invaluable for employees with children or dependent family members.
How Section 125 Plans Save Employers on Payroll Taxes
By enabling employees to pay for benefits with pre-tax dollars, a Section 125 plan reduces their taxable income, lowering your payroll tax obligations.
Specifically, employers save on Social Security, Medicare, and FUTA (Federal Unemployment Tax Act) taxes. Over time, these savings can be substantial—especially for employers in labor-intensive industries with large payrolls.
Why Section 125 Plans Are Important
Today’s employees expect more than just a salary.
Benefits matter a great deal to workers. A recent Mercer study showed that lower-wage employees value health and welfare benefits. Employees who receive significant health benefits are more likely to agree that their employer cares about them.
That translates to improved retention, lower turnover, better engagement, and higher productivity.
Employees want benefits that offer flexibility and meet their needs, especially when it comes to healthcare. Offering a Section 125 plan lets employees select the benefits that matter most to them. Options include health savings, child care assistance, and medical expense support.
This level of customization is a big draw for prospective hires and a valuable retention tool for existing employees.
How to Set Up a Section 125 Plan
Establishing a Section 125 plan involves a few critical steps:
- Create a Written Plan Document – The IRS requires a formal written plan document detailing the benefits you’re offering, who’s eligible, and how the plan works. This document forms the basis of your Section 125 plan.
- Choose the Benefits to Offer – Determine which benefits to include based on employee needs and your budget.
Popular options include health insurance, FSAs, and HSAs. However, there are many more potential benefits you can include, and administer within your Section 125, such as saving more on payroll taxes for every benefit your employees choose. - Meet Nondiscrimination Requirements – Section 125 plans must comply with IRS nondiscrimination rules to ensure they do not favor highly compensated employees. Your plan administrators can help you comply with these nondiscrimination rules, which can be complex.
- Communicate the Plan to Employees – Educate your team on the available benefits and how they work, including enrollment steps and deadlines.
FREE QUOTE
COLORADO COST-SHARING
Final Thoughts
A high-deductible health plan paired with an HSA is a popular choice for many employees looking to manage healthcare costs.
However, to be eligible to make HSA contributions, employees must be enrolled in a qualifying high-deductible health plan (HDHP) or, alternatively, in a health sharing plan in combination with a MEC (minimum essential coverage) plan.
A Section 125 Cafeteria Plan helps Colorado employers offer flexible benefits while saving on payroll taxes.
Whether you’re a small business or a larger employer, a Section 125 plan can make your benefits package effective and tax-savvy.
For Further Reading
Leslie Alford is a Personal Benefits Manager at ColoHealth. Her aim is to help you make smart and informed healthcare coverage decisions that will fit your needs and budget. Read more about Leslie on her Bio page.
