MONEY Magazine called it "The Tax Break You Can't Ignore." A flexible benefit plan is simply a program that allows employers to help employees pay for certain expenses (such as health insurance and dependent care) by pre-tax payroll deduction. Flex plans are extremely popular and effective, because employers not only have happier employees with additional take-home pay, but employers also save money on taxes.
The plan creates additional take-home pay for employees because expenses that are commonly after-tax expenses are paid by employees with pre-tax dollars. These expenses include:
- insurance premiums for eligible group plans
- out-of-pocket expenses for medical care not covered by insurance
- work-related child care expenses
Employee contributions made through the plan are exempt from federal income tax, state income tax, and FICA tax. As a result, employees typically save about 30% on eligible expenses. In other words, for every three dollars of expenses converted to pre-tax status, the employee takes home an additional dollar of income.
The plan also creates payroll tax savings for the employer, creating a "win-win" situation for companies. The employer is exempt from the FICA match (7.65%) on all employee contributions made through the plan. When you consider cumulative savings for all premiums, medical expenses, and dependent care expenses for all participants, tax savings over a full plan year can be substantial.
A very basic example of potential tax savings: Employee with a total annual flex election of $3,600 (combination of insurance premiums, Health FSA election, and/or Dependent Care FSA election) would realize tax savings for the year of approximately $1,080.00. In addition to the employee tax savings, the employer would save approximately $275.00 in payroll taxes due to the exemption from the FICA match on employee contributions.
How Does A Flexible Benefit Plan Work?
Flexible Benefit Plans (also known as "flex plans", "cafeteria plans", or "pre-tax plans") are established pursuant to Section 125 of the IRS Code. In accordance with Section 125, a flex plan allows for pre-tax treatment of three categories of expenses:
- Qualifying group insurance premiums - includes health, dental, group term life, disability*, ancillary products, Health Savings Account
- Out-of-pocket medical expenses (Health, Dental, Vision)
- Dependent care expenses - work-related child care for dependents age 12 years and under
For employers, once the initial details are understood, the plan is easy to understand and operate. For employees, enrollment in the plan is straightforward and easy to understand.
Insurance premiums: employees are automatically enrolled so that all premiums are paid on a pre-tax basis. Insurance premiums are remitted to the insurer as usual, but are now withheld from the employee's pay on a pre-tax basis rather than a post-tax basis.
Flexible Spending Accounts: employees may elect to participate in one or both of the FSA accounts - Health FSA and Dependent Care FSA. For FSA participants, an annual election is made at open enrollment, and pre-tax contributions are withheld on a pro rata basis throughout the plan year. Once an eligible expense is incurred, documentation is submitted (to ProBenefits) and the employee receives a tax-free reimbursement.
As with all tax-favored benefit plans, there are considerations to know and communicate.
- Annual Election: employee elections are effective for the full plan year. Employees may not change an election mid-year except in the event of a recognized status change.
- Annualization: This IRS rule (applicable only to the Health FSA) stipulates that a participant who contributes funds to the Health FSA has access to the full annual election at any time during the plan year. On occasion, the employer may have to advance funds to the bank account linked to the flex plan. Such advances are repaid from employee contributions in subsequent months. This rule is a reason why some employers choose to have an annual Health FSA maximum of $3,000-$5,000 instead of a higher amount.
- According to the IRS-mandated "Use-or-Lose" rule for FSA plans, any unreimbursed or unclaimed money at the end of the plan year is forfeited by the participant. When properly understood, this should be a plan consideration and not a deterrent to participation. There are a number of tools and options to prevent FSA forfeitures and to increase education and participation. One such option is the $500 Carryover.
Want to learn more about how an FSA can benefit your employees and you?