Why Cafeteria Plans Matter For HSAs

You may have heard that there’s no such thing as a free lunch. But by taking advantage of your employer’s cafeteria plan (also known as a Section 125 plan), you can get free money in extra tax savings from your HSA contributions.

What Is A Cafeteria Plan?

Cafeteria plans are employee reimbursement plans that are governed by Section 125 of the IRS tax code. When employers establish cafeteria plans, their employees have the option of making pre-tax contributions to their HSAs via payroll deferral. Without a cafeteria plan, employees only have the option to contribute post-tax and deduct their contributions from their tax return.

What’s So Good About Cafeteria Plans?

For employers, having a cafeteria plan means they don’t have to follow IRS comparability rules. Under comparability rules, if employers contribute to their employees’ HSAs, they have to make comparable contributions to all other comparable participating employees’ HSAs.

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Comparable contributions are either:

• The same amount

• The same percentage of the annual deductible limit for the HDHP that covers the employees

Comparable participating employees:

• Are covered by the company’s HDHP and are HSA-eligible

• Have the same category of health coverage (self-only or family)

• Have the same employment category (full-time, part-time, or former employees)

Under comparability rules, employers cannot make matching contributions to employees’ HSAs, although they are allowed to contribute more to lower-compensated employees’ HSAs.

For employees, cafeteria plans have a tangible benefit too. HSA contributions are always exempt from federal and state income taxes (in almost all states). However, when employees use their employer’s cafeteria plan to contribute to their HSAs via pre-tax payroll withholding, they also save on payroll taxes like FICA and FUTA. That’s an extra 7.65%! And pre-tax contributions through a cafeteria plan are the only way to unlock that extra 7.65% in savings.

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Also, employers don’t have to pay these payroll taxes on their employees’ pre-tax contributions through a cafeteria plan. Everyone wins! Employers also don’t have to pay payroll taxes on their own contributions to employees’ HSAs.

Is There Any Downside To A Cafeteria Plan?

Not for employees! Employers who offer cafeteria plans must follow IRS nondiscrimination rules, which forbid highly-paid employees from benefiting disproportionately from the plan as compared to lower-paid employees. However, nondiscrimination rules are generally less strict than the comparability rules employers would have to follow if they didn’t offer cafeteria plans. Nondiscrimination rules do not require employers to contribute similar amounts to their employees’ HSAs, which allows employers to provide matching contributions to employee HSA contributions if desired.

What If My Employer Doesn’t Offer A Cafeteria Plan?

If your employer doesn’t offer a cafeteria plan, you can’t open a cafeteria plan by yourself. And if you’re married, you can’t make pre-tax contribution into your spouse’s HSA. You’ll need for your employer to open a cafeteria plan so you can start taking advantage of those extra payroll savings.

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What If I’m Self-Employed Or A Business Owner?

Cafeteria plans are designed for employees. The IRS doesn’t consider self-employed individuals as employees, so they aren’t eligible for cafeteria plans. Also, LLC members, partners in a partnership, and 2% or greater owners of an S corporation are not allowed to make pre-tax HSA contributions through a cafeteria plan. C corporation owners are generally allowed to participate in cafeteria plans, however.

Bottom line, employers’ cafeteria plans are the most tax-advantaged way for individuals to contribute to their HSAs. If your employer offers an HSA cafeteria plan, you’re leaving tax savings on the table if you’re not participating in it.