A cafeteria plan, also called a flexible benefit plan, allows employees to choose from a menu of optional benefits the ones that best fit their individual needs. Thus, employees can customize their benefit packages. In a cafeteria plan, benefits required by law (e.g. Social Security, unemployment compensation, workers's compensation) and those mandated by company policies or labor agreements are supplemented by a list of other benefits to which employees can subscribe. Employees's choices of optional benefits are limited only by the total benefit dollars available and the variety of benefits offered by the employer. Optional benefits that are often part of cafeteria plans include dental insurance, vision care, group-term life insurance, child care, and disability insurance. Many companies offer some form of cafeteria benefit plan to their employees, although smaller companies are less likely to offer flexible benefits than larger companies.
Most cafeteria plans are compliant with Section 125 of the Internal Revenue Code. This means that they meet specific requirements set out by the Internal Revenue Service. Such plans offer the potential of cost savings to both employers and employees, particularly because amounts spent by either the employer or the employee are spent out of pre-tax earnings. Thus, both employers and employees may save on Federal Insurance Contributions Act payroll taxes and the employee may save on state and federal income taxes as well.
There are several variations of cafeteria plans, including core-plus plans and modular plans. Core-plus plans provide a set of mandatory benefits that are usually designed to meet the basic needs of all employees. In addition to legally-required benefits, medical insurance, long-term disability insurance, and retirement benefits are often included in the core. Optional benefits are offered to employees who spend benefit credits to select other benefits that best fit their needs. Modular plans usually package several different bundles of benefits that offer increasingly extensive arrays of benefits. The basic module might include only the legally-required benefits, basic health insurance, and life insurance. A second module might include everything in the basic module plus additional benefits. A third module might include everything in modules one and two and even more benefits. Employees would choose the module that best fits their needs and life situation.
Perhaps the largest problem with cafeteria plans, as opposed to one-size-fits-all benefit plans, is that cafeteria plans are more complicated to administer. Since employees choose individualized benefit packages, the company must take care to record and maintain each employee's benefit package accurately. The company must maintain adequate communication with employees about changes in the cost of benefits, their coverage, and their use of benefits. Employees must also be offered the opportunity to re-visit their benefit choices and make new selections as their needs and life situations change. Additionally, employers must be careful to comply with Internal Revenue Service (IRS) rules and regulations regarding cafeteria plans so that the plans retain their tax-favored status.
Another issue that arises with cafeteria plans is the adverse selection problem. This problem arises because employees are likely to choose the optional benefits they are most likely to use. If enough employees do this, the cost of the benefit will eventually be driven up, as the premiums received must cover the expenditures of the benefit. For example, suppose a company allows employees to change their cafeteria plan selections once each year. During this "free enrollment" period, an employee who knows (or suspects) that he or she faces extensive dental work in the coming year would be more likely to sign up for dental insurance than the employee who expects only routine dental care. Likewise, an employee who has begun having vision problems would probably be more likely to sign up for vision coverage than an employee with perfect eyesight. Sometimes, employers will place restrictions on certain benefits to try to alleviate the adverse selection problem. Modular plans may also reduce the adverse selection problem, as the employer can package benefits in a way that limits employees's opportunity to choose individual benefits, by requiring them to choose a broad package of benefits.
Given the increasing diversity of the labor force, the demand for benefit packages tailored to individual needs and circumstances is likely to remain strong. Thus, one would expect the number of companies offering flexible benefit plans to continue to increase, as well as the rate of employee participation in such plans.
SEE ALSO: Human Resource Management
Gomez-Mejia, Luis R., David B. Balkin, and Robert L. Cardy. Managing Human Resources. 4th ed. Upper Saddle River, NJ: Prentice-Hall, 2004.
Henderson, Richard L. Compensation Management in a Knowledge-Based World. 9th ed. Upper Saddle River, NJ: Prentice-Hall, 2003.