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What is Section 125? (Compliance Issues for Group Health Plans)

Section 125 Compliance

My friend shared this little experience she had as a little girl playing softball.

She was on 2nd base, ready to run. Her teammate hit the ball, and she tore off for 3rd as the ground ball made its way between 2nd and 3rd base. 

She jumped over the ball! 

At the same time, the ball hit a rock, popped up, and knocked her in the ankle. Wow, did that hurt!

But it didn’t deter her. Soon she was standing on 3rd base. Triumphant!

Until…the umpire told her she was out! 

She was in disbelief. It wasn’t her fault the ball popped up. She still made it to base before the 3rd baseman had the ball and tagged her out. What in the world!

Her problem was she didn’t know the rules. And the rules said, if the ball touches a runner, the runner is out!

Man, was she bummed! She had to comply with the rules. She was out!

The stakes are much higher for a business that finds itself out of compliance with government rules regarding their group health plan. 

More than leaving 3rd base and heading to the dugout, they face fines and fees. They can lose the option of using pre-tax dollars on qualified expenses. It can be a real problem.

And just like my friend in the little story above, not realizing you are out of compliance doesn’t protect you from the consequences of being out of compliance.

As an Employee Benefits Advisor at Baily Insurance Agency, I often find that businesses don’t realize their group health plan is out of compliance.

And one of the most common areas of non-compliance is with Section 125 of the IRS tax code. 

Are you sure your business is following what is outlined in this code?

To help you understand what the law requires of your group health plan, I’ve put together this short article to give you a thorough understanding of what you need to do to maintain compliance under Section 125. 

In this article, I answer these questions:

  • What is Section 125?
  • What benefits can be included in a Section 125 plan?
  • How does a Section 125 plan benefit my employees?
  • How does a Section 125 plan benefit me, the employer?
  • What does a business need to do to stay in compliance with Section 125?
  • How can I make sure my business complies with Section 125?
  • What role should my Employee Benefits Advisor play in helping with compliance issues?
  • What other compliance issues do I need to be aware of?

What is Section 125?

Section 125 is part of the federal tax code that outlines what a business needs to do if they are offering benefits to their employees that can be funded through the employee’s income before that income is taxed.

In the law, it states that your plan qualifies as a Section 125 plan if you have at least one taxable benefit option and at least one qualified pre-tax benefit.

In layman’s terms, at least one taxable benefit option means that your employees have a choice: They can use the income toward a benefit or opt to receive the income as taxable income in their paycheck.

And, one qualified pre-tax benefit could be anything from health and disability insurance to Flexible Spending Accounts (FSAs), Dependent Care Assistance Plans, Health Savings Accounts (HSAs), or contributions to a group health plan.

Let’s summarize here. Your business is subject to Section 125 requirements if:

  1. Your business offers benefits to your employees – such as health care benefits, child care benefits, etc.
  2. Your employees can choose to use some of their income to contribute to those benefits – i.e. they are using part of their income to fund the benefits like paying deductibles or contributing to an HSA.
  3. The contributions your employees make are removed from their income before it is taxed. 

What benefits can be included in a Section 125 plan?

According to the federal tax code, Section 125 plans can include:

  • Accident and health benefits (but not Archer medical savings accounts or long-term care insurance)
  • Adoption assistance
  • Dependent care assistance
  • Group-term life insurance coverage
  • Health savings accounts, including distributions to pay long-term care services

Often these plans are referred to as cafeteria plans. Like a cafeteria, these plans can offer a little of this and a little of that. 

How does a Section 125 plan benefit my employees?

A Section 125 plan benefits your employees because it allows them to use the money they have earned without it being taxed. In fact, it allows your employees to save about 20% on the wages they direct toward their benefits. 

Essentially, your employees can spend that money without it ever being taxed.

Also, those pre-tax dollars that your employees use toward their benefits can be used for spouses and dependents. 

How does a Section 125 plan benefit me, the employer?

Section 125 of the federal IRS code also has benefits for the employer. 

First of all, this benefit encourages your employees to enroll and pay for some of their benefits. 

Also, it exempts you, the employer, from payroll taxes on the money your employees use to contribute toward the benefits outlined in your plan.

For instance, for every $200 that your employees apply to their benefits, your company will save 7.65% of that amount. That 7.65% would otherwise be applied to social security and medicare taxes.

What does a business need to do to say in compliance with Section 125?

To comply with the tax code, your business will need to create three documents for your plan as well as offer open enrollment for your employees every year

It is also your responsibility to make sure your business is following what is outlined in your plan document. If you don’t, your plan could lose its pre-tax status.

Here is a list of the documents you will need to prepare:

1. A master plan document

This document must include the following:

  • The plan year
  • Any insurance benefits, carriers, and descriptions
  • Eligibility of the insurance benefits offered under the plan 
  • Eligibility requirements for participation in the plan 
  • Flexible Spending Account (FSA) minimum and maximum contributions (if offered) 
  • Non-elective (employer) contributions and elective (employee) contributions

2. An adoption agreement

This can be included in the Master Plan Document. In general, this document outlines the options that the employer chooses regarding the design of the benefits plan. It must be signed by the employer indicating it has been “adopted” as their plan.

3. A Summary Plan Description

This document, otherwise known as an SPD, must be made available to every employee that is eligible for your plan. They must receive this document within 90 days of being covered by your plan.

How often do these documents need to be provided for your employees?

According to the law:

  • Every 10 years you must provide your plan document to your employees.
  • Every 5 years, if you have updated your plan, you must provide an updated document to your employees.
  • Every year, you must provide an updated Summary Plan Description to your employees.
  • While not a document, it is important to also remember that you need to offer open enrollment in your program every year.

This seems complicated. How can I make sure my business complies?

You are right when you say this seems complicated. 

Government regulations regarding employee benefits have a lot of requirements that can be difficult to understand. Without outside assistance, it is very difficult for a business to be certain they are in full compliance.

One other thing that muddies the waters even more when considering your Section 125 plan (or cafeteria plan) is the number of options you can consider when designing your plan. 

To ensure compliance, you will need the help of an accountant or a payroll company. 

An accountant or a payroll company will, first of all, help you design your plan. After doing so, they will help you prepare all of the required documentation. Finally, they can provide ongoing assistance to make sure you remain in compliance with government regulations.

What role should my Employee Benefits Advisor play in helping our business stay in compliance?

This is a great question! Many businesses expect their Employee Benefits Advisor to help them construct their group health plan and do little more.

Your Employee Benefits Advisor should also play a role in helping you stay in compliance. Your Advisor should regularly communicate with your accountant or your payroll company about your plan and contact them with any updates to your plan. 

At a minimum, your Employee Benefits Advisor should communicate annually with your accountant or your payroll company. You should expect your advisor to help you maintain compliance.

What other compliance issues do I need to be aware of?

Section 125 is not the only government regulation that impacts group health programs. The Employee Retirement Income Security Act of 1974 (ERISA) and the Affordable Care Act (ACA) also place requirements on group health plans.

At Baily Insurance Agency, anytime we help a client design their group health plan, we place a high priority on compliance issues. 

Group Health Insurance is costly enough. We don’t want our clients to be unnecessarily burdened with government fines and fees, because they did not maintain compliance.

We also direct our clients to first-rate accountants or payroll companies that can help them get into compliance and stay in compliance.

At Baily Insurance Agency, we are committed to educating our clients about these complex issues. 

The next step to making sure your company is in compliance is to review the ERISA guidelines. Our article, Group Health Compliance: Is My Business ERISA Compliant?,  outlines what your company must do to satisfy this government regulation. 

If you have other questions about your group health insurance program, give us a call. We’d love to answer your questions today!


Related Articles:

6 Step Strategy to Creating an Effective Group Health Insurance Plan

Why Does Group Health Premium Go Up Every Year?