Cafeteria plan funded by employees only

[eilano]

An employer is thinking about establishing a cafeteria plan that is entirely funded by the employees. The employer will not pay for any premiums. All contributions will be made by the employees' pretax dollars. Can this be done?

[pjkoehler]

Absolutely, its permissible. In fact, the underlying insured plans may fall within the definition of "certain group or group-type insurance programs" that aren't even regarded as an ERISA Title I "welfare benefit plans." See 29 CFR Sec. 2510.3-1(j). The exemption requirements are quite stringent, so the employer may make a business decision not to operate the plans in that manner. But you should take a look at the reg to you can make a proper cost-benefit analysis. Whether or not the insured plans are ERISA Title I plans, the employee contributions are eligible for pre-tax treatment only if the program as a whole satisfies the nondiscrimination requirements of Code Sec. 125(B).

[IRC401]

Once the contributions are run through the cafeteria plan, they become employer contributions. I doubt whether the plan could qualify as a non-ERISA plan. In either case it will still be a fringe benefit plan for 5500 purposes.

[pjkoehler]

IRC 401, what is the authority for your claim that the taxable benefits (including cash) that an employee elects to forego in exchange for nontaxable benefits are transformed from employee contributions to employer contributions? The principal tax benefit of a nondiscriminatory cafeteria plan is that the highly compensated employees enjoy the exception to the constructive receipt rules that apply with respect to such elections under Code Section 125(a). Prop. Treas. Reg. Sec. 1.125-1, Q&A-9. The amounts withheld from a participant's paycheck as premium payments under the insured plans discussed in this thread, i.e. the "taxable benefits," are not "run through the cafeteria plan" in any accounting sense. A nondiscriminatory cafeteria plan is just a fringe benefit plan that supports the exclusion of the taxable benefits that the HCE elected to exchange for nontaxable benefits, from gross income, it's not an employee benefit plan under ERISA (plan, fund or arrangement). The amounts withheld from the employees' paychecks should be sent directly to the insurance carrier as premium remittances completing the exchange of the taxable cash for the nontaxable insured coverage. This has no impact on the whether or not the insured "nontaxable benefits" programs satisfy the exception under the ERISA regs from the definition of a "plan."[Edited by PJK on 08-29-2000 at 09:08 PM]

[IRC401]

1. Under IRC 125 an employee gets to choose between cash and qualified benefits. Whom do you think provides those benefits: (a) the employee, (B) Amazon.com, or © the employer? There must be an employer benefit plan (and 125 would make no sense otherwise).

2. I have never seen a 125 plan in which the principal tax benefit went to the HCEs (in their capacity as employees).

3. A premium conversion plan is not an ERISA benefit plan, but the plan for which premiums are being paid must be an employer plan, and I don't see how it would not be an ERISA plan (unless the employer is exempt from ERISA).

4. Suppose that 100% of the premiums for a LTD plan are paid through a 125 plan. When someone collects LTD benefits under the policy, is he taxed as if he paid the premiums or the employer paid the premiums?

[pjkoehler]

IRC 401, take a deep breath. Comments 1 and 3 confuse the treatment of amounts withheld from an employee's paycheck for tax purposes with their treatment under ERISA. For purposes of Code Section 125(a), a cafeteria plan provides a choice between taxable benefits (in the form of cash compensation) attributable to employer contributions and nontaxable qualified benefits attributable to employer contributions. The issue we're discussing is whether the underlying payroll-deduction based program for providing "qualified benefit" coverage rises to the level of an ERISA Title I "employee welfare benefit plan." The distinction you're making about salary redirections being treated as "employer contributions" for Code Section 125 purposes is not relevant to the ERISA analysis. Otherwise, you could say the same thing about an employee's elective deferrals under Code Section 401(k). They're also treated as "employer contributions" for qualification purposes. Does that mean that the DOL's plan asset regulations governing "participant contributions" don't apply to 401(k) plans? (That's a rhetorical question.)

As a practical matter most employers sponsoring 100% contributory welfare benefit programs wont satisfy the "nonendorsement" requirement of 29 CFR 2510.3-1(j). In any event, in view of the relief provided by DOL Tech. Rel. 92-1, plans where participant contributions are applied only to the payment of premiums to an insurance company or HMO within 90 days of the date the amounts were withheld from the paychecks will have a relatively light compliance burden, so they might as well take the position that they are ERISA plans.

Regarding point #2, if you don't think that the highly compensated individuals are the primary beneficiaries of favorable tax treatment under a nondiscriminatory cafeteria plan, then you haven't spent enough time with the proposed regs, especially Prop. Treas. Reg. 1.125-1, Q&A-9

Regarding point #4, most cafeteria plans that permit a choice of cash or LTD coverage on a 100% employee-paid basis, permit employees to choose between contributing on an after-tax or a pre-tax basis. Some employees will prefer paying after-tax, so that the LTD benefits would be nontaxable and they avoid reducing their FICA wages. Others will prefer making pretax contributions even though the LTD benefits would be generally taxable (subject to the limited disability income tax credit.) What is your point? Are you saying that amounts withheld from employee paychecks under a contributory LTD program are "employer contributions" to the extent they are excludible under Code Section 125(a), but they are otherwise (1) "participant contributions" or (2) "amazon.com contributions." (That's another rhetorical question.)[Edited by PJK on 08-31-2000 at 01:00 PM]

[IRC401]

You are the one who confused the issue. I never stated that a cafeteria plan was an ERISA plan. I merely stated that in order to have a cafeteria plan, you had to have an employer plan.

[pjkoehler]

IRC 401, what do you mean by "employer plan?" You keep using that term as though it had some precise meaning. Do you mean "employee benefit plan" within the meaning of ERISA Sec. 3(3)? Let's at least eliminate this source of confusion. 29 CFR Sec. 2510.3-1(j) provides that certain payroll-based programs that permit employees to obtain fully insured welfare benefit coverage are not "employee benefit plans" under ERISA Sec. 3(3). Nothing in the regulation resticts the exemption to arrangements with respect to which employee contributions are treated as after-tax.