What Is a Cafeteria Plan? A 2025 Guide to Tax-Saving Benefits

Every employee in your organization has different benefits requirements, especially when it comes to their medical needs. One worker may need coverage to support their diabetic child, while another seeks treatment for persistent back pain. And there will be some lucky enough not to require any medical support at this point in their lives. 

It’s clear that one-size-fits-all benefits don’t fit anyone perfectly. Instead? Cafeteria plans provide exactly what your workers need—choice. This guide explains more about how cafeteria plans work, their pros and cons, and compliance requirements. 

What is a cafeteria plan?

A cafeteria plan is an employer-sponsored benefits program that lets employees choose a personalized mix of taxable and nontaxable benefits for themselves and their dependents. Also known as a Section 125 plan, it’s named for its flexibility. Think of it like choosing a selection of dishes from a buffet—employees can pick the benefits that delight them and best suit their needs.

Cafeteria plans aren’t new. They were formally established under Section 125 of the Internal Revenue Code in 1978. Before that, offering employees a choice between cash and benefits often triggered tax consequences. The Revenue Act of 1978 changed that, allowing employers to offer customizable, tax-advantaged benefit menus, marking the beginning of what is now known as flexible benefits or cafeteria-style plans.

What’s included in a cafeteria plan?

The IRS defines a list of qualified, non-taxable benefits you can offer through a cafeteria plan. Employers can mix and match from this list to build a plan that supports employee needs while minimizing tax liability for both sides. Here are the most common qualified benefits:

• Group health insurance (medical, dental, and vision): Employees pay premiums with pre-tax payroll deductions.
• Health savings account (HSA): Contributions are tax-deductible and can be made through salary reduction arrangements if the employee is enrolled in a high-deductible health plan.
• Health and dependent care FSAs: Pre-tax flexible spending accounts (FSAs) are available for eligible out-of-pocket accident and health benefits or child/elder care expenses. 
• Group-term life insurance: The cost of coverage up to $50,000 can be excluded from an employee’s taxable income.
• Adoption assistance benefits: Tax-free reimbursement for qualified adoption-related expenses.
• Accident and disability insurance: Premiums offering coverage for injuries or illness are usually pre-tax; benefits may be taxable depending on how premiums were paid. 
• COBRA premium payments: Eligible employees can pay for continued healthcare coverage on a pre-tax basis while between jobs.

What’s not included in a cafeteria plan?

Even in the world of benefits pick-and-mix, not everything qualifies for pre-tax treatment. Some popular perks don’t make the cut under Section 125 rules, including: 

• Long-term care insurance
• Tuition reimbursement
• Gym memberships
• Commuter and parking benefits
• Cell phone stipends
• Moving expenses
• De minimis (low-value) perks, such as coffee and snacks

Employers can still offer these employee lifestyle benefits, but they need to handle them outside the cafeteria plan framework.

How a Section 125 cafeteria plan works

At its core, a Section 125 cafeteria plan is designed to be simple to run and access. Here are the nuts and bolts of how it works.

Step 1: The employer sets up the plan 

The employer designs the cafeteria plan by choosing a mix of benefits to offer. To qualify under Section 125, the employee benefits plan must include:

• At least one qualified benefit (like a cash option)
• One or more non-taxable benefits (like health insurance, FSAs, HSAs, or adoption assistance)

Step 2: Employees enroll in Section 125 during open enrollment

Each year, key employees choose their benefits during the open enrollment period, which is in the fall before the upcoming plan year. These elections are generally locked in for the entire year.

But employees can make changes outside of open enrollment if they experience a qualifying life event (QLE). These are specific personal or family changes that affect benefit eligibility and allow mid-year adjustments under IRS rules.

Examples of QLEs include:

• Getting married or divorced
• Having a baby or adopting a child
• A spouse gaining or losing coverage at their job
• Death of a dependent
• A change in employment status (e.g., going from full-time to part-time)
• Moving to a new ZIP code that impacts plan availability
• A dependent aging out of eligibility

Example: If an employee gets married in April, they may be able to add their new spouse to their health plan and adjust their FSA contributions, even though open enrollment has passed. They must act quickly: Most QLEs must be reported and addressed within 30 days of the event.

Step 3: Pre-tax deductions fund the benefits 

Once employees select their benefits, the cost is automatically deducted from their paycheck before income tax withholding is applied. These are called pre-tax payroll deductions. Essentially, they reduce the employee’s taxable gross income for federal income tax purposes.

This setup lowers both the employee’s income tax and payroll taxes (like Social Security and Medicare), while also reducing the employer’s payroll tax liability.

Example: Let’s say an employee earns $60,000 per year and elects to contribute $3,000 to a health FSA and $2,500 toward their share of health insurance premiums. That’s $5,500 in pre-tax deductions, meaning they’ll only be taxed on $54,500 of income, not the full $60,000.

At a combined tax rate of 30%, that’s a potential tax savings of around $1,650 for the employee. Meanwhile, the employer also saves on payroll taxes for high fives all around. 

Step 4: Employees can use their cafeteria and FSA plans simultaneously

Employees can contribute pre-tax dollars to an FSA while also using other cafeteria plan benefits like health insurance or dependent care assistance. To stay compliant, you’ll need to set a clear employer contribution limit for any FSA included in the cafeteria plan. Without that cap, the FSA isn’t considered part of the Section 125 plan and loses its tax benefits. 

4 types of Section 125 cafeteria plans

Employers can structure Section 125 plans in several different ways depending on headcount, benefits strategy, and administrative capacity. While each plan type differs primarily in scope and complexity, all must meet the requirements of Section 125 to maintain their tax-advantaged status. Below are the most common types of cafeteria plans employers offer:

• Premium-only plan (POP): As the simplest cafeteria plan structure, employees use pre-tax income to pay their share of insurance premiums, usually for medical, dental, or vision coverage.
• Flexible spending account (FSA): This arrangement allows employees to set aside pre-tax dollars for qualifying medical expenses. Funds are subject to the “use-it-or-lose-it” rule.
• Simple cafeteria plan: Small businesses with 100 or fewer employees can offer this plan type, which automatically complies with nondiscrimination rules if you meet certain minimum employer contributions, eligibility and participation requirements.
• Full flex plan (full cafeteria plan): Employees receive a set amount of employer-provided “credits” to spend on a range of qualified benefits. Pretax payroll deductions cover any additional costs. 

Note: Archer medical savings accounts (MSAs) are technically allowed under Section 125, but they’re limited to certain small employers and self-employed individuals and are largely phased out in favor of HSAs. 

How does the Employee Retirement Income Security Act (ERISA) impact cafeteria plans?

Along with conforming to Section 125 of the Internal Revenue Code, cafeteria plans must also adhere to the Employee Retirement Income Security Act—the federal law that governs most employer-sponsored benefit plans. Don’t worry, it’s easier than it sounds:

If your cafeteria plan offers ERISA-covered benefits like group health insurance, disability insurance, or adoption assistance, then you’ll need to follow certain documentation and reporting requirements, just like you would for a 401(k) or 403(b) retirement plan.

Here’s what that usually involves:

• Provide a summary plan description (SPD): Each employee enrolled in the plan must receive an SPD within 90 days of enrollment. This document outlines what the plan offers, how it works, who’s eligible, and how to file a claim.
• Maintain a written plan document: This is the official legal document that governs the plan’s operation. It must include eligibility rules, benefit options, and funding information.
• File form 5500 (if applicable): If your cafeteria plan includes welfare benefits like health, dental, vision, or disability insurance and has 100 or more participants, you must file an annual Form 5500 with the Department of Labor.
• Comply with nondiscrimination rules: Most Section 125 plans are also subject to nondiscrimination testing to check they don’t favor highly compensated employees. Simple cafeteria plans are exempt from these rules if they meet safe harbor requirements.

Note: ERISA doesn’t apply to all cafeteria plans; for example, those offering only non-ERISA benefits like HSAs or dependent care FSAs may be exempt from some requirements. But if you offer group insurance, ERISA likely applies.

Pros and cons of cafeteria plans

Like any type of employee benefit, cafeteria plans come with their own unique blend of advantages and disadvantages, whether considering them through an employer or employee lens. 

Pros

Here’s why so many organizations use cafeteria plans as a core part of their total rewards strategy:

Lowers tax liability for employees

Cafeteria plans enable employees to pay for benefits with pre-tax income, which reduces their taxable wages. The result is more take-home pay without increasing gross salary. 

Increases savings on employment taxes 

Meanwhile, employers also benefit from reduced payroll tax obligations, including Social Security and Medicare taxes. CEO Kuya William Peetoom describes the win-win: 

“Imagine being able to increase your employees’ take-home pay without raising wages… while simultaneously lowering your own business taxes and insurance costs.” 

Offers highly customizable benefits 

Employees can tailor their benefits to suit their individual circumstances, whether maximizing dependent care, enrolling in a health FSA, or skipping optional coverage altogether.

Supports diverse life stages

Cafeteria plans meet a wide range of needs, from young employees saving on premiums to working parents needing dependent care support.

Includes certain non-taxable benefits 

Common options like health insurance, disability coverage, adoption assistance, and HSA contributions are all non-taxable under Section 125 when included in a compliant plan.

Boosts retention and recruitment

Offering flexible, tax-efficient benefits is a strong differentiator in competitive hiring markets, especially for cost-conscious or family-focused employees.

Cons

There’s a bit of red tape involved with using cafeteria plans. But once set up, companies usually find that the long-term tax savings and employee satisfaction often outweigh the upfront complexity. 

Includes use-it-or-lose-it rules for FSAs

Some benefits, like health and dependent care FSAs, follow strict “use it or lose it” guidelines. If employees don’t spend their allocated funds by the end of the plan year (or grace period, if offered), the remaining balance is forfeited.

Provides limited enrollment flexibility

Outside of open enrollment, employees can only adjust their benefit selections if they experience a QLE. This can make cafeteria plans feel rigid for employees whose needs change mid-year.

Can be complex to administer

Especially for small or lean HR teams, managing cafeteria plans can require time and expertise, from setting up pre-tax deductions to ensuring proper documentation and ERISA compliance. Business advisor Jason Charles describes: 

“Some companies hesitate to implement Cafeteria 125 Plans due to perceived complexity or administrative burden. However, with the right guidance and tools, setting up and managing these plans can be straightforward and highly beneficial.”

Documentation and filing requirements for cafeteria plans

One of the biggest considerations of offering a cafeteria plan is also what makes it so powerful: customization. Because employees can build their own mix of benefits, no two elections may look the same. And that flexibility creates complexity on the backend for employers.

To stay compliant with Section 125 of the Internal Revenue Code, employers must maintain specific documents and follow key reporting rules for certain benefits.

Required plan documentation

Every Section 125 cafeteria plan must have a written plan document in place, as a legal requirement. The core documents include:

• Main plan document: Outlines the full structure of the cafeteria plan, including eligibility rules, available benefits, and how elections work.
• Adoption agreement: Specifies which benefits the employer is adopting under the Section 125 plan and confirms the employer’s participation.
• Summary plan description: Gives a plain-language overview of the plan that must be distributed to each participant within 90 days of enrollment. It includes key details on benefits, eligibility, claims procedures, and employee rights under ERISA.

Legal structure 

To qualify as a cafeteria plan, employees must be able to choose between at least one taxable benefit (like cash) and one qualified, non-taxable benefit (like health insurance or an FSA). If you don’t offer a taxable benefit, this doesn’t meet IRS standards for a Section 125 plan.

Keep in mind:

• The taxable benefit is treated as income and is subject to income and payroll taxes for that year.
• Self-employed individuals (including sole proprietors, partners, and more-than-2% S-corp shareholders) are not eligible to participate in cafeteria plans. These plans are reserved for W-2 employees.

Filing requirements 

Cafeteria plan filing requirements depend on whether the plan includes ERISA-covered welfare benefits, such as group health, dental, vision, disability, or adoption assistance.

• If the plan does include welfare benefits and has 100 or more participants, the employer must file Form 5500 annually with the U.S. Department of Labor.
• If the plan only includes non-ERISA benefits (like HSAs or dependent care FSAs), Form 5500 may not be required, but you’ll still need to maintain documentation. 

Simplify your employee benefits with Benepass

Offering cafeteria plans for your employees is made easy when you have the right support to guide you. Benepass is a versatile benefits administration platform designed to offer your employees choice, while making it easy to run on the backend. Here’s what you can expect: 

• Centralized benefits: Forget multiple vendors. Benepass consolidates FSAs, HSAs, dependent care programs, and commuter benefits into a unified platform, making administration simple and user experience intuitive.
• Flexible spending: Beyond cafeteria-plan benefits, your team can offer lifestyle spending accounts (LSAs), wellness stipends, family and childcare support, and more, all managed in one system. 
• Access to benchmarking data: Use insights from Benepass’s 2025 benefits benchmarking guide to compare your offerings, including pre-tax and stipend programs, with industry standards. Understand what other employers contribute, how programs are structured, and which benefits matter most.

Ready to give your employees the choice they want, need, and expect from their benefits program? Book a free Benepass demo today to see our platform in action, or contact sales@getbenepass.com to discuss your cafeteria plan queries with a benefits specialist.