Employer contributions (i.e., not salary deferrals) to a Flex Plan

[Guest JVH]

A company would like to start a flex plan and say to the employees that they will let them spend $4,000 of employer money (i.e., not salary deferrals) on qualified benefits in the 125 plan. The employer does not want the employees to take the money as cash compensation, but instead, the dollars must be used for qualified benefits, or they are lost. Is it OK that the employees don't have a choice of taking the cash even though they can chose among both pre-tax and after-tax benefits. In a sense, the employer will say that we will increase your comp. by "up to $4,000" if you select benefits under the plan. Does this pass Section 125. I see in the proposed regs that employers clearly can put money into the plan for the employees, but I'm hung up on the language of the plan being a choice between cash and qualified benefits.

[mroberts]

The plan can simply state that any unused funds out of the $4000 are forfeited. Most employers do NOT allow the employees to take the leftovers as cash since the money is there for benefits. You'd end up getting too many nitwits running around uninsured because they wanted the $4000.

[david rigby]

Remember that the employer can let "leftover" dollars can be directed to a 401(k) plan. In that case, the taxation of the $ changes a bit (FICA).

[401 Chaos]

I do not specialize in this area and am not sure I follow what you mean by the fact that "they can choose between both pre-tax and after-tax benefits" but I do not believe the 125 rules pose a problem to what the employer desires here. While 125 plans can and often do allow for cash-outs, I am not aware of anything in the 125 rules that require that all (or any) employer amounts be subject to cash-outs--only that participants have an ability to elect between deferring a portion of their salary to purchase benefits under the plan or taking those amounts in cash. Under Code sections 105 and 106 seems an employer could pay for medical care / health insurance premiums on behalf of the employees without raising compensation / tax issues so I suppose they can do so through by way of contributions to the cafeteria plan without raising cash or deferred questions provided the employee is given a choice as to any salary deferral amounts.

There are many variations on employer contribution arrangements which do not provide for cash-outs. Some plans, for example, provide "flex dollars" that allow all participants a set employer contribution amount from which to buy any of the various benefits offered under the plan (group health insurance, dental, vision, group life insurance, health fsa, etc.) with any amounts not used either forfeited or going automatically to a Health FSA which, by definition, is subject to the use it or lose it rules. That gives all employees the same amount but maximum flexibility to alter benefits for their particular situation. Or, as mrobets notes, the employer could design the plan such that all employer contributions go toward purchase of specific, limited benefits and remaining amounts pass to the FSA, etc. This is particularly popular for very high deductible health insurance arrangements where it is cheaper for employers to give everybody a huge contribution under the FSA that can be used to cover deductibles and co-pays, etc. rather than arranging for low deductible insurance for the group.

As Pax notes, unused amounts could also go over to a 401(k) Plan offered under the 125 plan; however, I believe there is some authority requiring that 125 plans offering a 401(k) option also offer a cash-out option (see August 1994 IRS Examination Guidelines for 401(k) Plans) thus including a 401(k) option could potentially result in some employees taking unused amounts in cash rather than having the amounts deferred under the 401(k) Plan which the employer does not seem to want to risk.

Also, keep in mind that such large employer contributions can change the nature of the Flex Plan for HIPAA Portability compliance purposes.