Cafeteria plans, created by the Revenue Act of1978 and governed by Section 125 of the Internal Revenue Code, are tax-qualified flexible benefit plans that offer employees choices in putting together their own benefits package by choosing from a list of options (thus, the term “cafeteria,” indicating a pick-and-choose approach to individualized benefits). The popular plan program allows employees to choose between taxable benefits (such as cash or vacation pay) and at least two nontaxable benefits (such as term-life, dental, or health insurance).

Cafeteria plans are characterized by “open enrollment” periods during which plan participants must choose and enroll for selected benefits. The plans are renewed on a yearly basis, and mid-year alterations or amendments are only permitted when there is a “change in status” of an employee (e.g., change in marital status, number of dependents, a change in residence, a change in employment status, or a return from unpaid leave).

Section 125 benefits plans, including cafeteria plans, allow pre-tax allocation of employee wages toward benefit contributions, thus reducing the employee’s taxable income. Another benefit plan qualified for Section 125 tax treatment is the Flexible Spending Account (FSA) which allows employees to set aside pretax monies to help pay for unreimbursed medical expenses and/or dependent care. However, in both forms of plans, unused benefits and unspent funds are forfeited.