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Are You Using Your Section 125 Wisely?

Oct 12, 2007
What is a Section 125? A section 125, or cafeteria plan, is a part of the Internal Revenue Code (IRC) Section 125 code that allows for certain qualified expenses to be purchased using money set aside in an account that employee has put money in with pre-tax dollars.

These cafeteria plans can be used for three different primary purposes: medical care, dependent care and transportation services. The content of this article focuses on medical reimbursement accounts and not the other two possibilities.

What a mouthful! Essentially employees of an employer who offers a Medical Reimbursement Account are allowed to put a set amount of money into their account with money the employee would not pay taxes on when depositing into the Section 125 account.

What this means is the money set aside avoids Federal Income Tax, Social Security tax,state taxes and potentially local taxes (check with your municipality.) So for every $100 deposited in to the Section 125 Medical Reimbursement plan, the employee is saving somewhere between 25-40% depending upon the employee's tax bracket.

What are eligible expenses? Eligible expenses are determined under the Section 125 plan and include those items detailed in the IRC Code and Section 213d of this code. Common expenses covered are dental services, orthodontia, vision and eye care and related supplies, diabetic supplies, over the counter medications and the list goes on and on.

By using your cafeteria plan to pay for known medical expenses, you can reduce your tax liability significantly. For example, if your child needs braces and your employer offers no coverage for braces, you could set aside the amount determined by the employer to be a maximum withholding. If the employer has said the maximum withholding is $3,000 per year, you can have a prorated amount withheld from your check each pay period. In our example, let's assume you are paid every other week or 26 times per year. You would have $115.38 withheld pre-tax each pay period for the year. You can then draw from the amount in the Section 125 and pay your orthodontia bills.

Meanwhile, you will be saving anywhere from 25-40% on the amount being withheld. This amounts to a savings of $28.85 per week to $46.15 per week depending upon your tax bracket. This is some pretty hefty savings over the course of one year ranging from $750 to $1,200.

There are many components of a cafeteria plan but the bottom line is that if you know you will have medical expenses and can have money withheld through a qualifying employer sponsored plan, take advantage of it.
About the Author
Scott is a partner in ESP Benefit Design, an employee benefits insurance firm based in Westerville, Ohio. (614-882-8535) Scott has an MBA from Franklin University. Scott has worked with over 6,000 customers. Email Scott at scott@espbd.com

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