8898 / How can a cafeteria plan be used by employers to offer employee benefits?

An employer may offer employees who are participants in a cafeteria plan a choice among two or more benefits consisting of cash and qualified benefits.¹ A cash benefit is not strictly limited to cash, but includes a benefit that may be purchased with after-tax dollars or the value of which is generally treated as taxable compensation to the employee (provided the benefit does not constitute deferred compensation).²A qualified benefit is a benefit that is not includable in the gross income of the employee because of an express statutory exclusion and because the benefit constitutes deferred compensation. Contributions to Archer Medical Savings Accounts, qualified scholarships, educational assistance programs, or excludable fringe benefits are not qualified benefits. Products that are advertised, marketed, or offered as long-term care insurance similarly do not qualify as qualified benefits.³

When insurance benefits, such as those provided under accident and health plans and group term life insurance plans, are provided through a cafeteria plan, the benefit is the coverage under the plan. Accident and health benefits are qualified benefits to the extent that coverage is excludable under IRC Section 106.⁴ Accidental death coverage offered in a cafeteria plan under an individual accident insurance policy is excludable from the employee’s income under IRC Section 106.⁵

Group term life insurance coverage on employee-participants can be offered through a cafeteria plan. Coverage may be offered through the plan even if it exceeds the $50,000 excludable limit under IRC Section 79.⁶ The application of IRC Section 79 to group term life insurance and IRC Section 106 to accident or health benefits is explained in Q 8789 to Q 8792.

Accident and health coverage, group term life insurance coverage, and benefits under a dependent care assistance program are still counted as “qualified” benefits even if they must be included in income because a nondiscrimination requirement has been violated.⁷

For tax years beginning after 2012, a health flexible spending arrangement (FSA) offered under a cafeteria plan is not a qualified benefit unless the plan limits employees to no more than $2,500 in salary reduction contributions for each tax year (the amount is indexed for later years, to $3,200 in 2024, $3,050 in 2023, $2,850 in 2022 and $2,750 in 2021).⁸ Beginning in 2014, up to $500 ($640 in 2024, $610 in 2023, $570 in 2022 and $550 in 2020 and 2021)⁹ of the balance of a health FSA may be carried forward to the subsequent tax year if the FSA incorporates a provision that permits such a carryover.

A cafeteria plan generally cannot provide for deferred compensation, permit participants to carry over unused benefits or contributions from one plan year to another, or permit participants to purchase a benefit that will be provided in a subsequent plan year. A cafeteria plan, however, may permit a participant in a profit sharing, stock bonus, or rural cooperative plan that has a qualified cash or deferred arrangement to elect to have the employer contribute on the employee’s behalf to the plan.¹⁰ After-tax employee contributions to an IRC Section 401(m) qualified plan are permissible benefits under a cafeteria plan, even if the employer makes matching contributions.¹¹

A cafeteria plan may permit a participant to elect to have the employer contribute to a health savings account (HSA) on the participant’s behalf (see Q 8825 to Q 8837).¹² Unlike other benefits, HSA balances may be carried over from one year to another even if they are funded through a cafeteria plan.

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Planning Point: Notice 20209 allowed employers to permit certain mid-year elections made during calendar year 2020 that would otherwise be impermissible, including changes to salary reduction contribution elections. The guidance also allowed participants to revoke (or make) an election with respect to health and dependent care FSAs on a prospective basis during 2020 to respond to changing needs during the COVID-19 pandemic. Further, the guidance clarified that the relief for high deductible health plans (HDHPs) and expenses related to COVID-19 (regarding an exemption for telehealth services) may be applied retroactively to January 1, 2020.

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Generally, life, health, disability, or long-term care insurance with an investment feature, such as whole life insurance, or an arrangement that reimburses premium payments for other accident or health coverage extending beyond the end of the plan year cannot be provided under a cafeteria plan.¹³ Supplemental health insurance policies that provide coverage for cancer and other specific diseases are not treated as providing deferral of compensation and are properly considered accident and health benefits under IRC Section 106.¹⁴

Participants in a cafeteria plan maintained by an educational organization described in IRC Section 170(b)(1)(A)(ii) (i.e., one with a regular curriculum and an on-site faculty and student body) can be permitted to elect postretirement term life insurance coverage. The postretirement life insurance coverage must be fully paid up on retirement and must not have a cash surrender value at any time. Postretirement life insurance coverage meeting these conditions will be treated as group term life insurance under IRC Section 79 (see Q 8681 to Q 8684).¹⁵

Under the Affordable Care Act, plans and issuers that offer dependent coverage must make this coverage available until a child reaches the age of 26.¹⁶ Even if a cafeteria plan has not yet been amended to provide coverage for children under age 27, the ACA allows employers with cafeteria plans to permit employees to immediately make pre-tax salary reduction contributions to provide coverage for these children in order to assist with implementation of the expanded coverage requirements.

Both married and unmarried children qualify for this coverage. This rule applies to all plans in the individual market and to new employer plans, as well as to existing employer plans unless the adult child has another offer of employer-based coverage. Beginning in 2014, children up to age 26 can stay on their parent’s employer plan even if they have another offer of coverage through an employer.

Employees are eligible for the new tax benefit beginning March 30, 2010 and thereafter if the children are already covered under the employer’s plan or are added to the employer’s plan at any time. For this purpose, a child includes a son, daughter, stepchild, adopted child, or eligible foster child. This “up to age 26” standard replaces the lower age limits that applied under prior tax law, as well as the requirement that a child generally qualify as a dependent for tax purposes.