SECTION 125 PLANS

 

 

            The United States Congress enacted the Revenue Act of 1978, which created Internal Revenue Code Section 125.  Section 125 plans, also called "cafeteria" plans, are employer sponsored plans that allow employees to pay for most medical and child care expenses on a pre-tax basis.  Such expenses include health insurance premiums paid through the employer, childcare or dependent care expenses, and most healthcare expenses, which are not reimbursed from any other source (such as an insurance company).  In other words, the amount of one's salary that is spent on these necessities will be tax-free under a Section 125 plan.  The tax savings include state and federal income taxes, as well as Social Security tax.

 

            No matter how comprehensive the medical insurance an employer provides, chances are there still are significant medical expenses each year.  The average American spends about $800.00 out of pocket for health care every year.  We can deduct these expenses on a tax return only if they exceed 7.5% of the adjusted gross income.  The average family is just not able to take advantage of the deduction on their tax return.  However, with a Section 125 plan, there is a tax break on any amount spent, regardless of income. 

           

            The following example illustrates the savings that could be experienced under a Section 125-cafeteria plan.  (Assume the employee is married with 2 dependents, and his gross income every two weeks is $700.00.) 

                                                                                                                                           Without                                  With

                                                                                                                                           Section 125                       Section 125

 

                                Gross Pay (per check)

                                 (26 checks per year)                                                                      $700.00                             $700.00

                                Less:

                                                Child Care                                                                                -.-                                  100.00

                                                Medical Insurance Premiums                                             -.-                                    25.00

                                                Health Care Expenses                                                           -.-                                    50.00

                                Gross Taxable Income                                                                 $700.00                              525.00

                                Less:

                                                Federal Income Tax                                                             63.00                                36.00

                                                Social Security Tax                                                              53.55                                40.16

                                                State Income Tax                                                                    3.70                                     .10

                                                SDI Tax                                                                                     6.30                                   4.73

                                Adjusted Income                                                                           $573.45                               444.01

                                Less:

                                                Child Care                                                                          100.00                                     -.-

                                                Group Medical Insurance                                                25.00                                     -.-

                                                Health Care Expenses                                                       50.00                                     -.-

                                Spendable Income Per Check                                                   $398.45                               444.01

 

                                TAX SAVINGS PER PAYCHECK                                                                                          $45.56