A “cafeteria plan” operates the same way the company lunchroom works. Hypothetically, an employee who stood in a cafeteria line with $10 in hand, and with the knowledge that $10 was the budget for lunch could proceed through the line buying whatever he or she wished to eat, subject only to the limitation that the employer first choose which foods to offer for sale that day.
In the same manner, a company-sponsored employee benefits “cafeteria plan” permits an employee to spend a certain fixed amount to choose whichever kinds of benefits he or she wants from the employer – subject to the limitation that the employer has first chosen which benefits to offer. For example, an employer may choose to put a number of different employee benefits on the cafeteria plan menu, including:
- Health insurance
- Life insurance
- Dental insurance
- Accidental death and dismemberment insurance
- Disability coverage
- Vacation leave
- Child care assistance
- Paid leave
- Contributions into retirement accounts
- Adoption assistance
- Cash, and/or
- Flexible spending accounts
Employers generally enter into a salary reduction agreement with their employees by which a certain amount of money is deducted from payroll in pre-tax dollars and set aside in the cafeteria plan. Legally speaking, these dollars are considered not to have been paid to the employee – thus there is no tax liability to the employee and no matching tax obligation by the employer. Both parties essentially save on taxes: Employees who make pre-tax contributions to cafeteria plans are not subject to federal, state, or social security taxes. Employers, in turn, save by not having to pay their portion of payroll taxes, specifically the Federal Insurance Contribution Act (FICA), Federal Unemployment Tax Act (FUTA), and workers compensation premiums.