Jump to content

Disadvantages to Cafe Plan


Guest summit2282
 Share

Recommended Posts

Guest summit2282

I am starting a research paper on Cafeteria plans. I am looking for any input on what you know about disadvantages to the employee on a Cafe plan, both health and daycare.

I know there is the "use it or lose it" rule and that the grace period has been extended to 14 months and 15 days. I also know that the plan reduces your taxable income which can also decrease some of your benefits like social security, pension, disability and life insurance when those benefits are based on taxable income.

I know that you must enroll annually and determine an annual election amount.

I know that you must submit claim forms and wait for reimbursement (some companies have the new Flex Debit Card)

Anyone know of more disadvantages to the EMPLOYEE?

Also, anyone know what the eligibility requirements are to participate in a cafe plan?

Link to comment
Share on other sites

Are you typing about flexible spending accounts under a cafeteria plan?

You have lots of ideas wrong. Yes it reduces taxable income, but NO it does not reduce contributions made to or for the participants to pension, profit sharing and 401k plans.

Think you need remedial lesson in flex spending and cafeteria plans before you try to ask questions.

The only disadvantage to the employee is if they don't make a good estimate of future expenses and some the funds are lost.

Eligibility requirement depend on how the employer set it up and what the different plan provisions are.

Like I said, you need to do some more studying before you go off half informed trying to ask questions.

JanetM CPA, MBA

Link to comment
Share on other sites

JanetM:

While your point about no reduction to retirement benefits is usually true, it is a matter of plan design and not all plans include salary reduction amounts in the defintion of compensation for determining benefits based on compensation. "Recent" law changes allow plans to neutralize salary reductions, but do not require it. As with so many other things that people take for granted, it depends.

Link to comment
Share on other sites

Guest summit2282

Janet M:

Just wanted to say thanks for your posting. Glad to know I got so much support....not!! It's so great to know that a "professional" such as yourself is so helpful to those of trying to learn!

I don't know who the heck you think you are, but I truely did not appreciate your input, so from now on, please stay out of my postings!

I am a new student who came across this message board with the hopes that it would help me learn some things. I didn't expect to run across such hateful people as yourself!

Oh, and by the way, before you go shooting your mouth off and putting others down, maybe you should be careful to read the postings correctly!! I never said that the contributions were lowered I mentioned the benefits could be lowered! Get it straight next time...oh wait, there should never be a next time.

Link to comment
Share on other sites

What do you mean "..a Cafe plan, both health and daycare"? I have no idea what you mean.

You do not submit claim forms for reimbursement in a Cafeteria Plan, although you must submit claims for reimbursement from an FSA or DCAP, which could be in the Cafeteria Plan. A cafeteria Plan does not have to have an FSA or DCAP.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

Link to comment
Share on other sites

Summit,

It's unfortunate that so many people are anal when responding to questions. It's fairly clear that you know what you're asking about. It's just that some folks seem to take things too literally. Techncially they are correct and it is true that it's very easy to get a wrong answer if the correct terminology, etc. is not used.

First, you can require up to 3 years to participate in a cafeteria plan. What GBurns is getting at is that a cafe plan is really just a tax vehicle. It is used to pay for benefits on a tax-free basis. The benefits are covered by other code sections (e.g., 129 applies to dependent care, 105 and/or 106 for health plans, etc.) (Why he doesn't understand what you mean about health and daycare is beyond me - it's obvious to anyone who has been dealing with cafe plans for any period of time). These underlying benefits may have different restrictions on eligibility requirements. While a cafe plan can require up to 3 years to enter, it's very rare to see that in a plan. Generally the range is immediate on date or hire to up to 1 year.

You are correct that it can impact SS (for those earning under the taxable wage base) and some other benefits - although QDROPHILE's post about the impact on retirement plans is correct. It depends on the design of the retirement plan.

Also, many plans don't permit long-term disability to be paid through a cafe plan b/c it results in taxable payments should the individual be disabled. A small tax savings today for a possible long stream of taxable payments is not a good trade-off.

You mentioned the fact that you're locked in for a year. Many people only refer to this rule when discussing health spending accounts or dependent spending accounts. But, it also applies to health insurance being paid through the cafe plan. Unless somone has a qualifying change in status, you could be locked into health coverage for the full year. It's rarely an issue, but I have seen it come up.

I think you're on target. Good luck with the research!!

Link to comment
Share on other sites

Guest summit2282

GBurns:

I thought that a cafe plan was the same as FSA and HSA. So are you saying that a cafe plan is something different? I was thinking that the cafe plan was the same as 125, but thanks to Bob's posting I see that each category has it's own number 129, 105/106, etc. Do you have any suggestions on a good place to get more clarification on exactly what a cafe plan is? If there is more to a cafe plan I'd really like to read up on it. Thanks for the info.

Link to comment
Share on other sites

Guest summit2282

Bob R:

Thank you so much for the information. The comments from everyone are very helpful for my research. I will definately keep your comments in mind while searching for more info.

I am trying to make a career move from a math teacher to accounting and I want to make sure that I do a thorough job while studying so that I will be ready when I actually switch jobs.

Isn't Section 125 the overall cafe plan and then 129, 105/106, 132, etc. the different sections under 125? I didn't realize that the cafe plan had so many subcategories. I knew about the health and daycare, but now I have learned about more areas like unreimbursed expenses, life and disability, and transportation. Any more you know of?

I understand what you all are saying about the disability being a taxable payment when you collect on the benefit. That makes sense.

My job in the research is to write about the "disadvantages to the employee." The person on my team writing about the advantages is taking the approach of more money in your paycheck because of paying less taxes. I have to refute that. I think I have a good jump on what I am going to write.

Thanks again,

Link to comment
Share on other sites

Read Treas Regs 1.125-1, 1.125-2 and 1.125-4 then do a Google search on "section 125 cafeteria plan". That way you should get the basic knowledge that you need and should have had before starting the project etc.

A section 125 cafeteria plan is a method for avoiding the constructive receipt of the money that is being "re-directed" to pay for the eligible qualified benefits. The qualified benefits are provided under IRC sections such as 105, 106, 129 etc. The list is in IRC section 125 and the Treas Regs.

The only thing that a section 125 cafeteria plan is, is a means of pre-taxing the amounts. A section 125 cafeteria plan provides no other benefits. Any other benefits are derived from the applicable IRC sections not from 125.

There are basically 2 forms of cafeteria plans, a Premium Only Plan (POP) and a full Flex Plan. The full Flex Plan is the 1 that can have the FSA and DCAP features. There are vastly more POPs than full flex. That is another reason why I do not understand what you mean.

A cafeteria plan is not the same as an FSA nor an HSA.

You should not see any disability insurance being pre-taxed, so that should not be an issue. It is just no longer sold that way. You also would not see any life insurance except the group term life (up to $50,000).

There is usually no effect on the employee's Social Security benefits because not only are the amounts not usually enough to have an effect, but also because of the way that the benefit is calculated. You can run a simulation through the Calculator available on the SSA website. Use the latest Earnings & Benefits Statement that an actual person has received from SSA and plug in the income with and then without the cafeteria plan amounts and you will see whether there is any effect at all.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

Link to comment
Share on other sites

You know Summit, there are many people on this board trying to help others. This field is pretty "picky" due to complex (and sometimes contradictory) regulations promulgated in not such a neat manner. The tone of your original posting seemed to be of a leading nature. Perhaps a discussion of the pros and cons of utilizing a cafeteria plan might have been in order, rather than lashing out at the responses you got to your original post (you do know, BTW, that some of the same people who may be assisting or interviewing you in your career change might be the ones you are attacking here - a little food for thought).

The principal "con" as previously stated is overestimating funds deferred and having them revert to the employer (ever wonder why so many eyeglasses are purchased in November/December each year). In my personal case, I have my share of family health premiums and a medical expense account in my cafeteria plan. As stated before, these do reduce your income for Social Security purposes, both on the employer and employee side (my earnings are over the Taxable Wage Base so this is moot, but could affect some folks' ultimate SS benefit). However, as GBurns points out, the effect, if any would be minimal, given the 12.4% tax savings inherent in reducing the FICA tax; coupled with the incredibly progressive nature of the SS ben calc (you're likely talking about a reduction in the AIME subject to the 15% formula) I wouldn't even worry about it.

Given that the amounts put into a Caf plan are not subject to Fed, State, FICA, and Medicare tax, there is a fairly significant tax savings on these amounts. Costs paid by the Caf funds aren't going to be any different if paid instead after-tax. Sure, some plans can specify compensation net of deferrals, so you could potentially see a reduction in qualified plan benefits. But let's assume that you have $5,000 in play in the cafeteria plan, marginal tax rates of 28% Fed, 5% State, 7.65% FICA, and that you have $5,000 in qualifying expenses in the year so no worry of reversion.

Further, let's "worst case" this scenario and say that you forego 10% in employer contributions to a qualified plan (ie, that your plan uses comp net of deferrals - most add back).

So by participating in the Caf plan:

$5,000 expenses are paid pre-tax. You lose $500 in contributions to the plan. SS benefit is negligible (and won't go off on the true SS tangent that these benefits, especially for a younger worker, are mythical).

And how does that impact the SS benefit? Worst case, your AIME for the year loses the $5,000. So divide $5,000 by 35, then again by 12. To be charitable, let's multiply by a factor of 2 to adjust for future increases in Average Earnings. So, delta of AIME is $23.81 (5000/35/12*2). Now take 15% of that = $3.57. There's your upper bound of reduction of SS benefit (if at all).

By not participating in the Caf plan and paying the $5,000 after-tax:

$5,000 takes $8,424.60 in pre-tax dollars to pay ($5,000 / (1 - .28 -.05 - .0765). You get $500 contribution.

Pre-tax savings of $3,424.60 less $500 loss of contribution. Still seems pretty favorable to the cafeteria side of life. Think that you've been assigned the more difficult side to defend...

Link to comment
Share on other sites

A couple of clarifications I'd like to make about Sec. 125, Cafeteria Plans.

FSA or Flexible Spending Account, can be a Medical FSA or a Dependent Care FSA.

A Sec. 125 plan can be designed to include or exclude either one or both FSAs, in other words, the choice of pre-tax payment of benefit options can be limited to eligible insurance premium payments, referred to as a Premium Only Plan in an earlier post. Depending on the Sec. 125 Cafeteria plan design, the benefit options can include pre-tax premium payments, and/or a medical FSA and/or a Dependent Care FSA.

Tax exempt, (vs. tax deferred), more accurately reflects the tax status of eligible expenses paid pre-tax under a Sec. 125 plan. Eligible expenses paid on a pre-tax basis (excluded from taxable income) under a Sec. 125 Cafeteria plan are not currently included in taxable income nor are such pre-tax benefits deferred until a later date, but are instead excluded from taxable income, period.

I would not recommend Google searches as a reliable research source for IRS compliance, and particularly not for Sec. 125 info. There are several subscription services available for research of the IRS Code, Revenue regulations, ruleings, etc., in addition to other compliance issues.

The disadvantages to the employee participating in a Sec. 125 Cafeteria plan, maybe one of the most overlooked is the Dependant Care FSA. The general rule that service dates must be performed and paid within the Sec. 125 Cafeteria plan year, employees don't always take this into account when making DC FSA annual elections. Employees often make their Dependent Care FSA elections based on weekly/bi-weekly/semi-monthly/monthly DC expenses and multiplying the amount by the respective dependent care payments within the plan year. The result is a service period can begin in one plan year and end in a subsequant plan year, resulting in not being eligible for payment in either plan year.

Employees do not always account for family vactations which may or may not be charged by a dependent care provider.

DC provider's schedules may vary during the holiday season, and accounting for it is sometimes overlooked by employees when making DC FSA elections. Plan years ending mid-week don't usually coincide with Dependent care provider payment/service schedules. There are ways of getting around these 'disadvantages', but EEs must consider these or other situations when making their DC FSA elections under Sec. 125 Cafeteria plan.

Lower paid employees are not always aware that using a DC FSA will result in forfeiting the dependent care tax credit. The DC tax credit for lower paid employees provides greater tax advantage than excluding the DC expenses thru a DC FSA under a Sec. 125 Cafeteria Plan.

Link to comment
Share on other sites

Of course, please let me know this area of the country where child care can be found for $5,000 for the year ;) so that this could be a significant problem. For too many folks, that $5k max is exhausted somewhere around Memorial Day...

Link to comment
Share on other sites

Of course, please let me know this area of the country where child care can be found for $5,000 for the year ;) so that this could be a significant problem. For too many folks, that $5k max is exhausted somewhere around Memorial Day...

It's a side bar but.... Up until last year I was fortunate enough to have 5k childcare. But darn it if she didn't raise her rates to $110 / week (2 week vacation) to put me up to $5,500. But, I do recognize that she's the anomaly. One of those people who truly do the job "for the children". And, I did constantly run into the same issues that were mentioned above...re: vacations and service at eoy. Now that she raised her rates it's actually a relief that it's no longer an issue.

Link to comment
Share on other sites

LRDG

Google was recommended along with the law library sources. Remember the need here is for the basic introductory level explanations not detailed treatises which pre-suppose some in depth knowlegde.

Thanks for bringing up the DCAP vs DC credit issue. It is very important and often forgotten until the tax loss hits.

Maybe 2 or 3 years ago we had an indepth discussion on the issue and someone posted a comparison and worksheet. It should be worthwhile for summit2282 to search the Board for it. Or someone might be kind enough to give the link.

The DC tax credit, the "use it or lose it" and the 1 year election commitment are probably the only disadvantages to a cafeteria plan.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

Link to comment
Share on other sites

based on my experience, lower paid employees find affordable child care providers, NY to NM, irrespective of geografic locations or 'area of the country' .

middle and higher income EEs with child care expenses often exceed the maximum 5k.

The income of an employee population is not a selective process undertaken by an administrator.

It's not personal either.

Link to comment
Share on other sites

Well, I guess that we have arrrived at a conclusion here as to the "disadvantage" of a cafeteria plan (or for that matter a qualified plan). If your income or personal circumstances negate the tax advantages provided, then don't sign up. This is up to the individual participant. For many of us though, the ability to pay expenses we otherwise would incur pre every conceivable tax known to man (including AMT) kind of sways us to opt in. Let the buyer beware...

Link to comment
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
 Share

×
×
  • Create New...