What is a Cafeteria Plan?

A cafeteria plan is a special type of employee benefit plan. Companies offer it to their workers. It lets employees pick the benefits they want, like different kinds of insurance and retirement plans. These benefits are given to workers instead of extra pay.

Why It’s Called a “Cafeteria Plan”

It’s called a “cafeteria plan” because it works sort of like a cafeteria. At a cafeteria, you go through the line and pick the foods you want on your tray. You get to choose what you like. A cafeteria plan is the same idea. The company gives you a bunch of benefit options, and you get to pick the ones you want in your “benefits tray.” You pick what works best for you.

A Cafeteria Plan Gives You Choices

The main point of a cafeteria plan is choice. Every worker is different. They have different needs when it comes to stuff like health insurance, life insurance, and saving for retirement. What works for one person might not work so well for someone else.

With a cafeteria plan, the company isn’t forcing a one-size-fits-all benefits package on everyone. They’re saying, “Here are some options. You pick what you need.” This way, employees can build a benefits plan that makes sense for their own situation.

How a Cafeteria Plan Works

Here’s the deal with how cafeteria plans actually work:

The Company Decides the Options

The company running the cafeteria plan is in charge of deciding what benefit options to include. They might work with an insurance company or benefits manager to figure this out.

Common things you see in cafeteria plans are:

Health insurance (different kinds, like HMOs and PPOs)
Dental insurance
Vision insurance
Life insurance
Disability insurance
Flexible Spending Accounts (FSAs) for healthcare costs
Retirement plans like 401(k)s

The exact options depend on the company. Some might have tons of choices. Others keep it simple with just a few.

Employees Make Their Picks

Once the company has the cafeteria plan all set up, it’s time for workers to decide what they want. This usually happens when you first get hired or once a year during “open enrollment.”

The company will tell you what all the options are. They should explain stuff like:

What each insurance plan covers
The monthly premium costs
Deductible amounts
Copays
Limits on the accounts

You look at the menu of benefits. Then you choose which ones to sign up for based on what you think you and your family will need.

Paying for Your Benefits

So how do you actually pay for this stuff? Easy. It comes straight out of your paycheck each month. The company takes the money for your insurance premiums or retirement contributions before you even see it.

A lot of these cafeteria plan benefits are paid for with “pre-tax” dollars. That means the money comes out of your check before taxes are calculated. This is a good deal because you avoid paying taxes on those amounts. It lowers your taxable income.

Changing Your Benefits

Your life changes. Maybe you get married, have a kid, or develop a health issue. When that stuff happens, your benefit needs might change too.

Normally you have to stick with the benefits you chose until the next open enrollment period. That’s usually once a year.

But if you have a “qualifying life event,” the rules say you can change things up. The IRS has a list of what counts. It’s stuff like:

Getting married or divorced
Having a baby or adopting
A spouse losing their job
Moving to a new area

If one of those things happens to you, let your HR department know. You might be able to add or drop certain benefits outside of the normal open enrollment time.

Pros and Cons of Cafeteria Plans

Are cafeteria plans all sunshine and rainbows? Not quite. Like anything else, there are good points and bad points. Here’s a quick rundown:

The Pros

Choices, choices, choices. Love options? Cafeteria plans have ’em. You can pick benefit plans that work with your lifestyle.
Tax savings. Paying for benefits with pre-tax money means a smaller tax bill. That’s more cash in your pocket.
Flexibility as life changes. Had a big life event? With a cafeteria plan, you’re not locked into the same benefits forever. You can swap things around when you need to.

The Cons

It’s complicated. With so many benefit options to wade through, it can make your head spin. People might make less-than-perfect choices because they’re overwhelmed.
Lack of guidance. Companies offer the benefits, but they don’t always do a great job helping people understand them. Employees might be on their own to figure out the best options.
Limited choices. While cafeteria plans have multiple options, they’re not unlimited. You’ve still got to choose from the menu the company selected. If you don’t like what’s offered, too bad.
Temptation to underinsure. Because the employee is in charge of picking their benefits, some might be tempted to skimp on important things like health or disability insurance. But that can cause major problems down the road.