In today's diversified workplace, no two employees are alike. Each of them has different needs. One way that your employer can provide you with a wide variety of benefits is through a cafeteria plan, also known as a flexible benefit plan. A cafeteria plan allows you to choose from an array of benefits and customize a benefits package that is based on your individual needs. You can purchase benefits from the plan by using either a flexible spending account or a dollar amount that your employer previously allocates to you. Cafeteria plan benefits are not included in your gross income as wages.

It is important that your employer comply with the provisions of Section 125 of the Internal Revenue Code. Section 125 provides an exception for cafeteria plans from the "constructive receipt" doctrine. Under that doctrine, you are taxed on money or property that you have a free election to receive, even if you choose not to receive it. If the conditions of Section 125 are not met in your employer's cafeteria plan, you are taxed on the value of any taxable benefits that are available from the plan, even if you choose a nontaxable benefit.

Taxable (cash) versus nontaxable (qualified) benefits

A cafeteria plan allows you to choose from among both taxable (cash) and nontaxable (qualified) benefits. As a result, a cafeteria plan allows you to save money by paying for benefits on a pretax basis rather than with after-tax money. Taxable benefits include not only cash, but also any benefits that you purchase with after-tax dollars or the value of which your employer would normally treat as taxable compensation. Taxable benefits can include: cash, car and homeowners insurance, and group legal services. Non-taxable benefits are not included in your gross income. Nontaxable benefits can include health insurance , group term life insurance , and dependent care assistance .

Example 1: Big Corp. offers its employees $2,000 worth of cafeteria plan benefits. Jack, who is unmarried and has no children, elects to receive the $2,000 in cash. Since the cash is a taxable benefit, Jack must pay taxes on the $2,000. Diane, who is married and has two children, elects to spend the $2,000 on dependent care and health insurance for her children. Since dependent care and health insurance are nontaxable benefits, Diane does not have to pay taxes on the $2,000 worth of benefits. Finally, Angie, who is married and has one child, elects to receive $1,000 in cash and spend $1,000 on dependent care assistance. Angie will have to pay taxes on the $1,000 in cash, but does not have to pay taxes on the $1,000 for dependent care assistance.

Typically, your annual election from a cafeteria plan is irrevocable. However, the IRS allows you to revoke your election in certain situations. For more information on the IRS allowance of revocation of an election, see IRS Proposed Regulation, Section 1.125 and IRS Temporary Regulation, Section 1.125.

Methods of funding cafeteria plans

A flexible spending account allows you to contribute pretax dollars to an account that may later be used to reimburse you for benefits you purchase through the cafeteria plan. The pretax dollars that you use to fund the account usually come from a salary reduction program.

Premium-only

A premium-only cafeteria plan limits your available benefits to the payment of insurance premiums. A premium-only plan allows your employer to pay for a certain amount of your health coverage while you pay the remaining difference with pretax dollars through a salary-reduction program.

Add-on

An add-on cafeteria plan provides you with basic low-level benefits and allows you to supplement or add on to those benefits. Employers usually use add-on plans when the benefits they provide are below the norm.

Opt-up/opt-down

Under an opt-up/opt-down cafeteria plan, your employer provides you with both high- and low-level benefits. If you decrease your benefits to a lower level, you receive credits that are payable to you as taxable income. If you increase your benefits to a higher level, you pay for the extra cost, usually through a salary reduction program.

Core plus options

Under a core plus options cafeteria plan, your employer establishes a minimum level of core benefits to provide to each employee. The plan then allows you to supplement your benefits beyond the core benefits that your employer provides to you under the plan. You can supplement the core options with such benefits as additional life insurance or dental and vision care benefits. You can usually supplement your core benefits by either purchasing benefits with credits or through a salary reduction program.

Modular

Under a modular cafeteria plan, your employer combines certain benefits into packages and allows you to choose the benefit package that suits your particular needs. NOTE: Under a modular plan, you cannot pick and choose benefits from the various packages.

Example 1: ABigCompany allows its employees to choose from three types of benefit packages using the modular approach. The first package provides medical insurance with a $150 deductible, dental insurance, $125,000 in life insurance, and long-term disability insurance--all at a cost of $275 per month. The second package provides medical insurance with a $300 deductible, dental insurance, $75,000 in life insurance, and minimal long-term disability--at a cost of $150 per month. Finally, ABigCompany's third benefit package provides a basic medical plan with a $500 deductible, no dental plan, $15,000 in life insurance, and no long-term disability--at a cost of $75 per month.

Full-flex

Under a full-flex cafeteria plan, your employer places a price on all benefits that he or she makes available to you under the plan. You are then given a certain amount of credit with which to purchase benefits. Under a full-flex cafeteria plan, you are usually given the option to opt out of benefits and take all or some of the credits in cash.