The structure and operation of Section 125 plans — which allow employers to offer certain benefits on a pre-tax basis — is one of the hardest things for employers to master.
So, I thought it might be helpful to explore the top nine misconceptions about Section 125 benefits.
1. Employers do not need a Section 125 plan document in place in order for employees to pay for qualified benefits (for example, health, dental, vision premiums) pretax.
Truth: A written plan document is mandatory and should be amended or restated from time to time, to remain current.
2. Most group health insurers and health plan third-party administrators are experts on Section 125 plan rules and regulations.
Truth: Most are relatively unfamiliar with Section 125, and do not keep track of which employer clients are operating under a Section 125 plan and which are not. For example, most do not keep a copy of the employer’s Section 125 plan document on file.
3. Everyone who is eligible under the health plan may participate in the Section 125 plan.
Truth: Only employees are eligible to participate in the Section 125 plan. Certain individuals, such as partners in a partnership and over 2% shareholders in an S-corporation, are ineligible to participate. While spouses and dependents cannot participate, they can receive tax-favored benefits as beneficiaries. Meanwhile, nontax dependents, such as certain domestic partners, cannot. Check with your tax adviser. Double-check the eligibility section in your document.
4. If a certain midyear election change is not permissible under the Section 125 plan document but is allowed by a component plan (for example, the health plan), it’s OK to allow the change.
Truth: The terms of the Section 125 plan document must be followed. The salary reduction election must remain in place unless the Section 125 plan permits the change. Similarly, the health insurer or administrator is not bound by eligibility terms in the Section 125 plan that differ from those in the health plan documents. If hours and waiting-period requirements, for example, are included in your Section 125 plan document, double-check that those terms are in sync with your health plan documents.
5. Section 125 plan documents must include all permissible status changes (aka, qualifying events), as defined by the United States Treasury.
Truth: Employers are not required to include all permissible events in the plan document. Now is a good time to double-check if your plan excludes any of these and if there continues to be a solid rationale for doing so. For example, two new status changes that many employers have not adopted are related to Affordable Care Act marketplace enrollment opportunities.
6. Employee pretax health savings account contributions don’t flow through a Section 125 plan, and shouldn’t be listed as an available benefit in the Section 125 plan document.
Truth: The only way to allow pretax contributions to an HSA is through a Section 125 plan. Consult with your benefits adviser and double-check that pretax HSA contributions are allowed in your Section 125 plan.
7. Health reimbursement arrangement dollars may flow through a Section 125 plan.
Truth: HRA contributions may only be made by employers and are not a permissible benefit under Section 125. This rule, for example, doesn’t permit HRA dollars to be available to employees within a traditional cafeteria plan offering.
8. It’s a good idea to allow employees to pay for supplemental medical products (e.g., accident, cancer, hospital indemnity) pretax through a Section 125 plan.
Truth: This allowance can quickly open up a compliance Pandora’s box for employers and should generally be avoided. Check with your tax adviser and attorney. Resist the temptation to take guidance on this matter from the vendor selling these products.
9. Fully insured health plans are exempt from Section 125 nondiscrimination testing.
Truth: Section 125 nondiscrimination testing (not to be confused with the delayed ACA nondiscrimination rules) applies even if the plan is insured. It also applies if the plan is self-funded.