Cafeteria plans, also known as Section 125 plans, allow employers to offer certain benefits to employees tax-free.

A cafeteria plan allows employees to choose between at least one taxable benefit (often cash) and at least one qualified benefit—a benefit whose cost to the employee is excludable from their taxable gross income. The employee’s share of the cost is paid through pretax payroll deductions.

Without a Section 125 plan, employee contributions can only be made with after-tax dollars.

Pretax dollars can be used to pay for benefits, which can result in tax savings for employees. For example, an employee who spends $200 a month on benefits can save $60, assuming about 30% of the $200 would have gone to federal, state, local, and FICA (Social Security and Medicare) taxes.

The employer also saves on taxes: For each $200 a month that an employee sets aside, the employer saves about $15- the 7.65% of the employee’s wages that the employer would otherwise have paid in FICA taxes.

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