The other type of Section 125 Cafeteria Plan in addition to Pop's is called a "Full Flex Cafeteria Plan." These plans include all of the insurance premium tax-savings benefits of Pops but also adds the additional tax-savings potential for two other categories of expense. The first category is employee dependent-care expense (usually childcare, but adult custodial care is permitted under some circumstances). The second category is expenses for medical-dental-vision expenses not covered by insurance. With Flexible Spending Accounts (or "FSAs"), the employee is permitted to legally avoid paying taxes on up to $5,000 per year of dependent-care expenses and an amount of medical-dental-vision expense potentially limited only by the employee's income. Flex Accounts are much more complex than POP plans and it is rare to find an employer with the staff and expertise and to handle the necessary administrative duties. And the penalties for violation of the rules with flex accounts are potentially much more severe than for POPs. A good third party administrator ( Or "TPA") is usually required.

Medical-Dental-Vision FSAs.

Use of a Medical-Dental-Vision FSA (hereafter, "Medical FSA') is a way of saving taxes on the money employees think they will be spending in the next year on family medical, dental, vision and other health care costs. The amount they elect will be deducted from their pre-tax earnings. This money will not be reported in the employee's earnings to the IRS. It is "converted" from pay to a benefit, so no taxes are ever withheld or owed. The maximum annual contribution is set in advance by the employer. A typical limit would range from $3,000 to $5,000 per year, although it could be as high as the employer wishes. Use of a $5,000 FSA will save most employees somewhere between $1,132.50 and $1,732.50 per year (it could be more, depending on their marginal tax rate). The same $5,000 FSA will save the employer $382.50 in matching FICA. This is a tax-saving that will be noticed!

Expenses Eligible for a Medical-Dental-Vision FSA.

Generally, the same health-related expenses deductible on Schedule A of IRS Form 1040 are eligible under a Medical FSA. Expenses incurred by employees or dependents for many kinds of medical, dental, hearing, vision, physical therapy, some kinds of counseling and many other health-related costs may be included. Expenses covered by insurance are not eligible, but employees may claim their deductibles and co-payments under their insurance plans. Generally, any expense deductible on the Federal Income Tax Return for personal or family health may be included, regardless of whether a family member is covered by the group's health insurance plan. And recently, the IRS has ruled that employees can use flex accounts to pay for over -the -counter medications used to treat sickness.

Many expenses often not covered by insurance are eligible for a Flex Account. This would include dental expenses such as routine cleanings, exams, x-rays, fillings, crowns, bridges and so forth. It would also include vision expenses like eye exams, eyeglasses and contact lenses. In addition, many other sorts of expenses not covered under employer-sponsored insurance plans may qualify for a FSA. For example, the IRS has determined that employees can use FSAs to pay for Lasik Surgery. This is an expensive procedure and reducing the cost by 23-35% (or more) can be a tremendous benefit to employees who need it.

Another major expense not typically covered (at least, not generally covered very well) under employer-sponsored dental plans is orthodontics. Employees may use Flexible Spending Accounts to pay for orthodontic expenses. Orthodontic expenses typically cost a great deal of money, so that the tax saved through use of a Flex account is often thousands of dollars.

Most of us never get to deduct our out-of-pocket health expenses on our IRS tax returns because our expenses do not exceed the threshold of 7.5% of Adjusted Gross Income. There is no minimum threshold with the FSA. The employee enjoys a tax-saving beginning with the first dollar put into a flex account.

Reimbursement under a Medical FSA.

After the employee estimates the annual expense and completes the necessary paperwork, the payroll department divides the annual election by the number of pay periods left in the Plan Year. For example, a $3,000 annual orthodontic expense deducted biweekly, would result in a $115.38 deduction from each paycheck. Since the employee would pay no tax on this amount, the employee's actual paycheck would reduced by only about $75 for an employee in the 28% tax bracket. The employer's biweekly tax liability on this employee would be reduced by $8.83.

It is possible for the employer to handle the reimbursement of the employee's Medical FSA internally. But for most employers, the demands of doing so are too costly in time and dollars. Besides, the technical knowledge required to administer flex accounts is beyond that possessed by most groups.

If you decide to take advantage of the TPA services offered in our program, the plan would work as follows. Every pay period, the employer would either deposit this money into a checking account set up for this purpose or transmit the funds directly to the TPA account. The money goes into a sort of escrow account where it is held pending submission of a claim. There are three ways to file a claim and recover the funds.

First, the employees can mail a copy of their bill or receipt, (please note that the employee is not required to pay the bill before submitting it for reimbursement). Second, they may fax the bill or receipt. Third, if the group elects, the employees may recover monies from their flex accounts by means of a debit card. This method, if elected, would permit the employees to pay for their qualified expense (up to the balance in their account) by presenting the debit card to the health care provider. The debit card carries the Master Card logo and looks much like any other Master Card.

If the employee uses the mail or fax methods, the employee will probably have the reimbursement check within a week. If it is paid by direct deposit, the employee will probably receive the money within 2 business days. Of course, if the debit card method is employed, reimbursement is instantaneous.

Child-Care FSAs

Eligible Expenses for a Child-Care FSA

The purpose of a Child-Care FSA is to reduce the employee's reportable income by the amount of their dependent care expenses. If the employee is providing custodial care for dependents (under the age of 13) in order to work, they may be able to use a Section 125 FSA to eliminate taxes on a dependent care expense of up to $5,000. If the employee cares for an adult requiring custodial care, the employee may eliminate taxes on that expense if the adult is claimed as a dependent on the employee's tax return.

For employees paying $5,000 or more per year for day-care (not an uncommon amount), the tax savings will range from $882.50 to $1,992.50 per year-depending upon their marginal tax rate. The employer would save $382.50 per year in meeting FLCA. To the extent the employee participates in a Dependent Care Spending Account, they may not claim the year end child-care tax credit. However, for most people, the Child-Care Flex Account tax-savings will exceed the end-of-year tax credit.

Reimbursement under a Child-Care FSA

After employees estimate their annual out of pocket daycare costs and this amount will be deducted throughout the year in equal pre-tax deductions from their paycheck. When the expense is incurred, the employee will submit a receipt along with a claim form for reimbursement. The claim will be processed and reimbursed with tax-free money from the employee's account. The claim check is either mailed directly to the employee's home or direct-deposited to the employee's checking account.

If the dependent care is paid on a contracted amount, meaning that the amount the employee pays is the same each payment period, the employee can set-up the account to pay on a recurring system. To set up this method of reimbursement, the employee will need to submit a reimbursement form along with a copy of the contract from their provider stating the amount and schedule of the payment. With this system in place, the expense will be reimbursed on the same payment schedule without the need for further claim submission.

How Section 125 Plans with Flex Accounts Work:
Let's look at an example in which an employee making $3,000 per month pays insurance premiums in the amount of $500 per month, child-care in the amount of $400 per month and un-reimbursed medical, dental or vision expenses averaging $100 per month.

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Tax-Savings to Employee: $271.50 per Month ($3,258.00 per Year*)
Tax-Savings to Company: $ 76.50 per Month ($918.00 per Year)

(*Based on W-4 Withholding Allowance Status: S-O. Source IRS Publication 15-T (rev. June2003)).

Presenting Section 125 Plans to Your Employees

One of main reasons employers are reluctant to offer Section 125 plans (especially Flexible Spending Accounts) to their employees is that they do not feel qualified to answer the employees' questions and to walk them through the enrollment process. Professional Benefit Plans can offer the services of one of our trained representatives, (usually at no cost) to guide your employees through the process of enrolling in your Section 125 Plan. We will, of course, be available to answer any questions you may have as the employer and to guide you through the steps of setting up your plan.


©Professional Benefit Plans, Inc., 2003. This article may not be reproduced in whole or in part without the expressed written permission of Professional Benefit Plans, Inc.

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