Cafeteria benefits are also known as section 125 plans after the section of the federal IRS Internal Revenue Code that defines and authorizes them. They are a newer way to give employees access to tax-free health insurance and other qualified benefits.

With traditional employment benefits, the employer decides what benefits are available to employees and how much the employer contributes towards each benefit. Employees can decline or accept those benefits. If they decline, they forfeit the value of the benefit. If they accept, they may have to pay a certain portion of the benefit cost, but they cannot contribute their own additional dollars to upgrade the benefit or pick a different plan.

For example, an employer may offer to pay for 80% of the employee premium in the company’s group health plan A, for 60% of a family premium, for 50% of term-life insurance policy B, and for 50% of accidental insurance policy C. How much the employer actually pays depends on each employee’s decision to accept or decline each option. Employees typically do not know the dollar value of the benefits that are offered, and perceive different subjective values depending on their personal need for health insurance.

With a cafeteria benefit plan, the employer gives every employee the same dollar amount that the employee can spend on his/her choice of benefits in a cafeteria-style menu of options. The employer still decides on the list of options, but there are more choices available. The employee knows exactly how much money the employer is paying for benefits, making it easy to compare total compensation offers when looking at different job opportunities.

Most importantly, cafeteria plans allow employees to contribute more of their own personal dollars, tax-free, to buy the benefits they want. For example, an employer with traditional benefits might offer to pay 75% of the premium for a limited benefit plan with a $2,000 deductible. The employee has no choice of plans and his/her tax deduction is limited to the employer-selected premium. With a cafeteria plan, the employee can choose a more comprehensive health plan and get a bigger tax exemption to help pay for that more expensive premium. Employees can also put tax-free money in a personal Health Savings Account to cover out-of-pocket expenses.

If the employee does not want to spend all of the employer’s contribution on benefits, the employee can keep the remaining cash. However that cash becomes part of the employee’s pay, so it is subject to payroll taxes as well as federal and state income taxes. This means that an employee loses 25%-50% of any portion of the employer’s contribution that he or she takes in cash instead of buying benefits.

The Massachusetts proposal pioneered the use of cafeteria benefit plans as part of a healthcare reform strategy. Cafeteria benefits have two key advantages for that purpose:

• Combined with a statewide health insurance purchasing pool, cafeteria benefits allow employees to purchase an individually owned, portable health plan of their choice, instead of an employer-sponsored group coverage plan.
• Money spent on buying health insurance through a cafeteria plan is free from payroll and income taxes. Compared with other ways for individuals to fund part of health coverage costs, for instance individually paid premiums, state income taxes or sales taxes, this results in less tax money being paid to the federal government, meaning lower costs for New Mexicans.

Many medium and large businesses are already offering cafeteria benefits to their employees. All employers can. There are no paperwork filing requirements: an employer only has to write and keep an internal document that shows the list of qualified benefits offered through the cafeteria plan. The state insurance purchasing pool can easily help employers setup such a plan, provide consolidated monthly statements, and make benefit administration a lot easier than it is today.