Cash-in-lieu option must follow Section 125 IRS rules

There are times when an employer wants to make additional compensation available to employees as an alternative to the employer’s share of the premium for health insurance. Known as a cash-in-lieu-of-benefit option, the IRS has strict rules governing the practice. First and foremost, it can only be done through the employer’s Section 125 Cafeteria plan.

Cafeteria plan basics

A qualifying cafeteria plan exists when a company offers its employees a choice between cash and at least one other valuable pre-tax benefit, such as group health insurance. When an employee selects the cash or opt-out, he or she is choosing cash-in-lieu of benefits. The cash-in-lieu option is only available to employers and employees through a Section 125 Premium-Only or Cafeteria Plan.

Basic rules on implementing cash-in-lieu option

An employee may prefer to take the cash instead of the insurance coverage offered in the employer’s cafeteria plan because their spouse has excellent coverage for the whole family. The employer may allow this as long as they follow the rules on the Section 125 plan cash-in-lieu option. Here are three scenarios and how the rules apply to each:

A company wants to offer employees a choice between coverage through its group health insurance plan or compensation.

The company must offer these benefits under a Section 125 Premium-Only or Cafeteria Plan (with a written plan document in place). Otherwise, employees cannot pay their share of premiums with pre-tax salary deductions, and there can be no cash-in-lieu option.

An employer with a Section 125 cafeteria plan in place also has a cash-in-lieu option separate from the cafeteria plan.

Attempts to provide employees an opt-out cash benefit outside of the cafeteria plan may void the pre-tax feature of the plan for all employees.

An employer that does not provide group health insurance to employees through a Section 125 plan wants to give employees additional compensation as a cash-in-lieu option to buy their health insurance on the ACA exchange or open market.

An employer without a Section 125 plan offering group health insurance may not give employees additional compensation intended to help the employee purchase health insurance on their own. The only exception to this rule is the QSE-HRA plan for qualified small employers (with fewer than 50 employees).

ACA affordability rules

Employers with 50 or more full-time employees are under the Affordable Care Act mandate to provide affordable health insurance coverage to employees. This means the employee’s share of the cost of group health insurance cannot exceed 9.56% of the employees household income.

When an employee receives a cash-in-lieu-of-benefit, there is an opportunity cost that must be factored into the affordability equation. The ‘opportunity cost’ in this case is the amount available to the employee in additional compensation if he or she foregoes the group insurance benefit.

Let’s say an employee’s household income is $4,000 per month, while the monthly premium for group health insurance to cover the entire family is $300 per month. The premium passes the affordability test at 7.5% of household income.

However, if the employer offers a $150 opt-out for employees, that is considered an opportunity cost for those choosing to pay the health plan premium. This is added to the employee’s share of the premium ($300) for a total of $450 per month total cost of health insurance. That does not meet the affordability test at 11.25% of the employee’s household income. The company may be in violation of the affordability rule and subject to ACA penalties.

The QSE-HRA option

Small employers already exempt from the ACA mandate have another option — the Qualified Small Employer Health Reimbursement Arrangement (QSE-HRA). A qualified small employer has fewer than 50 full-time employees.

The QSE-HRA lets the employer provide funds to be reimbursed directly to the employee for their purchase of health insurance on the ACA exchange or the open market. Not only is no health plan required, the company may not have one at all. For more information on the QSE-HRA, click here.

Plan Document requirement

Every Section 125 plan to pre-tax benefits requires a written plan document per IRS rules (26 U.S. Code § 125 (d) (1)).

Companies looking to offer a Section 125 cafeteria plan may do so for as little as $99 with a Core 125 plan document package.

Core Documents provides employers with everything they need to establish an IRS- and DOL-compliant Section 125 cafeteria plan in PDF format for just $99. This cost reflects a one-time setup fee, not an annual charge. For an additional $50, employers can choose the Deluxe Binder option that includes the PDF email version plus a printed plan document in a 3-ring binder.

Setting up the plan document package

Clients love how easy it is to install the Core 125 plan document package in three easy steps:

1. Design your plan:

• Choose your plan year according to the calendar (Jan-Dec) or your tax year (Jul-Jun, for example) — a short plan year is available for the first year.
• Determine the rules and limits of your plan — our order form takes you through it step-by-step.

2. Order your plan:

• Place your order for the Core DCAP plan document package.
• Your personalized plan document package arrives at your inbox, usually the same day.

3. Start your plan:

• Print, review, and sign the plan document where indicated;
• Give a copy of the participant packet to each eligible employee; and then,
• Keep the Core DCAP plan document on file with other personnel paperwork — there is no requirement to file the plan document with any agency.

$99 one-time fee in PDF via email*

$149 one-time fee in PDF email* + Deluxe Binder via USPS

Order Online

Our secure online ordering system accepts:

If you prefer to order by fax, click here.