Simple Cafeteria Plan Could Address Health Insurance Fears
Originally published: 04.01.11 by Mike Coyne
New model is said to satisfy potentially costly nondiscrimination requirements.
President Obama’s healthcare reform has many small business owners worried. On the horizon, employers are faced with complying with complicated nondiscrimination rules or paying significant tax penalties for noncompliance. At the same time, there is a fear that health insurance costs will escalate even more rapidly than they have in the past in order to pay for mandated benefits under health reform. But what if there were a way to avoid complying with the nondiscrimination rules, to avoid the penalty taxes, and to pass on much or all of any increase in premium cost to employees? That just may be possible with a “simple cafeteria plan.”
A simple cafeteria plan is a new type of benefit plan created by the healthcare reform that was passed last year. It is available only to employers with less than 100 employees, and unlike a traditional cafeteria plan, it is relatively simple and inexpensive to administer.
However, before discussing details of the simple cafeteria plan, it is important to understand how a regular cafeteria plan works. A cafeteria plan, sometimes called a Section 125 plan, is a benefit plan under which employees have a choice between taxable and tax-free benefits. You may already have the simplest form of cafeteria plan, which allows an employee to pay his or her share of health insurance premiums with pre-tax dollars. Such premium-conversion plans are considered cafeteria plans because the employee has a choice between receiving taxable wages or making a tax-free contribution to health insurance.
A cafeteria plan is frequently more elaborate than a simple premium-conversion plan. It can provide an employee with a menu of tax-free benefits, including plan group term-life insurance, health reimbursement account benefits, and dependent-care benefits.
The problem with traditional cafeteria plans is that they are complicated to administer. First, the cafeteria plan must comply with nondiscrimination rules that are designed to assure that no more than 25% of tax-free benefits go to highly compensated employees. (For this purpose, a “highly compensated employee” is an officer, 5% or more shareholder, an employee earning more than $105,000, and a spouse or dependent of any such individual.) In addition to complying with the cafeteria plan nondiscrimination rules, the employer must comply with the non- discrimination rules applicable to each specific tax-free benefit offered under the plan (such as dependent care, medical expense reimbursement, and group term life insurance). Whether an employer can satisfy all of these nondiscrimination tests is largely dependent upon the types of benefits selected by the employees. It is not simple, and so consequently, few small employers have adopted traditional cafeteria plans.
The simple cafeteria plan is a true improvement that can benefit small employers. Under the simple cafeteria plan rules, an employer is required to make a minimum contribution. In exchange for that minimum contribution, the simple cafeteria plan automatically satisfies all of the applicable cafeteria plan and individual benefit nondiscrimination tests.
The required minimum contribution is surprisingly modest: either (a) a uniform percentage of at least 2% of compensation, whether or not the employee makes salary-reduction contributions to the plan, or (b) a matching contribution that is the lesser of 200% of the employee’s contribution or 6% of the employee’s compensation. For example, for an employee earning $35,000 per year, the minimum contribution might be a matching contribution of as much as $2,100 or a non-matching contribution of $700.
The new law is explicit that the nondiscrimination requirements for group term-life insurance, health-reimbursement accounts and dependent-care assistance are waived under a simple cafeteria plan. Although there is not a specific reference to insurance benefits, representatives of the Internal Revenue Service have suggested on numerous occasions that regulations will make it clear that health insurance provided through a simple cafeteria plan will automatically satisfy the new nondiscrimination rules.
We will have to wait for the regulations. But if the regulations are as promised, small employers can solve their health insurance problems by simply contributing a minimum of 2% of pay to the cost of insurance for all employees.
Michael P. Coyne is a founding partner of the law firm Waldheger Coyne, located in Cleveland, OH. For more information of the firm, visit: www.healthlaw.com or call 440.835.0600.
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