Chapter 17-Cafeteria Plans Rationale for Use To make employees more aware of benefits by giving them a dollar amount to spend To better meet the needs of a diverse group To enable employers to pass on increasing costs of benefits;

Definition Any benefit plan that allows employee choice Technically, it is a plan that meets the requirements of section 125 of the IR Code; a plan under which all participants may choose between two or more benefits consisting of qualified benefits and cash Cash – actual receipt of dollars; a benefit provided on a taxable basis as long as it is not prohibited by section 125

So what are qualified benefits? Any welfare benefit excluded from taxation under IRS code except scholarships and fellowships, transportation benefits, educational assistance, and employee discounts Group term life insurance in excess of $50,000 A 401(k) plan but not other deferred compensation plans

Benefit Election Must be made prior to beginning of plan year Cannot be changed during plan year unless allowed by plan AND for one of these reasons: Changes in family status Separation from service Cessation of required contributions Plan cost changes Plan coverage changes

Payroll Deductions & Salary Reductions Flexible spending accounts: Pre tax contributions: Used primarily for medical, dental & dependent care expenses A separate election for each benefit must be made prior to beginning of plan year and can only be changed under certain circumstance Monies in employee accounts are forfeited to company if not used during the year Election reduces taxable income and wages on which social security taxes are paid There is some risk for employer since the full annual amount must be available at any time

Types of Plans Core-Plus Most common type of cafeteria plan Basic core is provided to all employees, plus a second layer of ‘optional’ benefits is offered Additional benefits may be purchased with employer contributions and possibly, after-tax employee contributions

Types of Plans Modular Employees choose among several pre-designed benefit packages One package usually at no cost; others require employee contributions, usually through payroll deductions Growing in popularity as adverse selection is more easily controlled and plans are easier to communicate and administer

Types of Plans Salary-reduction Only Can be stand alone or be part of a broader cafeteria plan Premium conversion plan (also called a premium only plan –POP- ) allows an employee to elect a before tax salary reduction to pay his/her contribution to benefits; for example, dependent care health insurance coverage paid in full by employee; for medical and dental expenses only as otherwise there are tax consequences FSA- flexible spending accounts – fund certain benefits on a before tax basis; again, for medical and dental expenses not covered by employer’s plan or for dependent care expenses

Obstacles to Use Legislation; rules are clear, but still changing Meeting non-discrimination rules: No more than 25% of tax-favored benefits can be provided to key employees Eligibility test Employees with at least 3 years of service must be allowed to participate Eligibility rules must not discriminate in favor of highly compensated employees

Obstacles to Use Negative Attitudes Employer obligations Employees: if their support isn’t gotten in advance Unions: who feel they should bargain for what’s best for employees Insurers: who are conservative and worry about adverse selection Employer obligations If unused, will morale suffer? Will faulty choices by employees create liability for employer?

Obstacles to Use Costs Adverse selection Initial start-up costs are modest Continuing administrative costs are higher, but software Adverse selection It is a problem, when choice is allowed Methods for controlling: Limitations and restrictions when changes are made Proper pricing of options Minimal benefits for certain coverages

Issues in Plan Design Level of employer contributions May be based on factors such as salary, age, family status, length of service Should be large enough that employees can purchase benefits at least equivalent to prior plan Types and amounts of benefits to include Collect employee input to improve offerings There must be a balance between needs and costs

Change of Benefits It is costly and increases adverse selection Usually allowed no more than once per year