What Is a Section 125 Plan?
A Section 125 plan—also called a "cafeteria plan"—is a benefit program authorized by the IRS that allows employees to pay for certain qualified expenses using pre-tax dollars. This means the money comes out of their paycheck before federal income tax, Social Security tax, and Medicare tax are calculated.
The result? Employees take home more money, and employers pay less in payroll taxes. It's one of the few win-win scenarios in employee benefits.
How Section 125 Plans Save Money
Here's a simple example of how pre-tax benefits work:
Without Section 125
- Gross Pay: $4,000/month
- Taxes (25%): -$1,000
- Health Premium: -$300
- Take Home: $2,700
With Section 125
- Gross Pay: $4,000/month
- Health Premium: -$300 (pre-tax)
- Taxable: $3,700
- Taxes (25%): -$925
- Take Home: $2,775
Types of Section 125 Plans
- Premium Only Plans (POP) — The most common type. Employees pay health insurance premiums with pre-tax dollars.
- Flexible Spending Accounts (FSA) — Employees set aside pre-tax money for medical expenses or dependent care.
- Full Cafeteria Plans — Employees choose from a menu of benefits including health insurance, life insurance, disability, and more.
Section 125 Plan Requirements
To comply with IRS regulations, Section 125 plans must:
- Be established through a written plan document
- Offer at least one taxable benefit (usually cash/salary) and one qualified benefit
- Only cover eligible employees
- Follow non-discrimination rules
- Restrict mid-year changes to qualifying life events
The Optiv Health Difference
Optiv Health provides a turnkey Section 125 supplemental health plan that goes beyond basic premium conversion. Our plan includes:
- 1,000+ free generic prescriptions at $0 copay
- Unlimited 24/7 telehealth visits
- Pre-tax premium deductions
- Full compliance with IRS Section 125 requirements
- Simple enrollment and administration
The average employer saves $600-900 per employee per year while giving employees better coverage than they had before.
Section 125 vs Traditional Health Benefits Comparison
| Feature | Traditional Benefits | Section 125 Supplemental |
|---|---|---|
| Tax Treatment | After-tax premiums | Pre-tax premiums (7.65% FICA savings) |
| Prescription Coverage | High deductibles, copays | 1,000+ generics at $0 copay |
| Telehealth Access | Limited or high-cost | Unlimited 24/7 access included |
| Implementation Time | 6-12 months for changes | 2-3 weeks turnkey setup |
| Disruption to Existing Coverage | Requires benefit changes | Supplements existing plans |
| Employee Cost | Rising deductibles/copays | Lower net cost due to tax savings |
| Compliance Management | Complex multi-carrier coordination | Single-source compliance included |
FICA Tax Savings Explained
FICA (Federal Insurance Contributions Act) taxes fund Social Security and Medicare. Both employers and employees pay 7.65% FICA tax on wages—but not on qualifying Section 125 benefit contributions.
Real Example: 100-Employee Company
Section 125 Plan Rules and Regulations 2026
Section 125 plans must comply with strict IRS regulations. Here are the key requirements for 2026:
📋 Written Plan Document Required
Must have a formal plan document outlining all benefits, eligibility rules, and administrative procedures. We provide compliant templates.
⚖️ Non-Discrimination Testing
Plans cannot favor highly compensated employees. Annual testing ensures compliance with IRS non-discrimination rules.
📅 Change Restrictions
Employees can only change elections during open enrollment or qualifying life events (marriage, birth, divorce, etc.).
💰 Contribution Limits
2026 FSA contribution limit is $3,200. Health FSA funds are "use or lose" with limited carryover options.
🏥 Qualified Benefits Only
Only IRS-approved benefits qualify for pre-tax treatment. Our supplemental plans meet all qualification requirements.
📊 Annual Reporting
Plans require Form 5500 filing and other reporting. We handle all compliance documentation and submissions.
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