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Employee benefits programs: The full breakdown

At a glance:

  • What are employee benefits?

  • Are employee benefits taxable?

  • Types of employee benefits

  • Cafeteria plans

  • Financial planning with your employee benefits

  • Summary of Employee Benefits Programs

In the United States, employee benefits programs promote economic security for employees. They provide health, retirement, and other benefits to help raise living standards and also to help companies stay competitive in the marketplace.

In some form or another, employee benefits go all the way back to the early colonial days. Nowadays, some benefits are required by law, but many are provided voluntarily by businesses.

What are employee benefits?

Employee benefits, also called fringe benefits or perks, are forms of non-wage compensation provided to employees in addition to their normal wages or salaries.

They are offered in the private sector as well as the public sector. Independent contractors may also have access to some of the company's benefits despite not being actual employees (examples may include equipment and stock options). Temporary and as-needed employees also may.

Advantages for employees

Employee benefits have purposes. They increase economic security for employees. They protect employees and their families from economic hardship caused by disability, illness, unemployment, loss of life, and other events. Some benefits also serve as perks to help make an employee's job easier and more enjoyable. Benefits also make employers more attractive in the hiring market. Many times, a job applicant will be torn between two job offers but be swayed by one because it offers more generous benefits.

Advantages for employers

Employers, in turn, find that by offering benefits, they can attract and keep talented employees. They find that benefits increase morale among workers.

The extent to which a company offers benefits depends on many factors. One is the level at which a company needs to compete in the marketplace. Another is how much it can afford to pay in benefits. A third is its position in the lifecycle — startup companies generally offer very little in benefits, while established companies generally offer many. Companies in decline often trim back their benefits to save money, which can accelerate their decline as they lose employees.

Who pays for benefits?

Employee benefits may be paid for entirely by the company or by a combination of employer contributions and employee contributions. In some cases, they are subsidized partly or wholly by a third party. Employee contributions are typically deducted from paychecks. The amount that employees contribute can depend on many factors, such as the health of the company, the cost of the benefits in the marketplace, and whether the benefits are subsidized by a third party.

For public sector benefits, employer contributions are paid for through tax dollars, since, by definition, the state or federal government is the employer. Benefits may be expanded or curtailed based upon the budget health of the state or, sometimes, political policy.

(Graphic: Hannah Smart/Cashay)
(Graphic: Hannah Smart/Cashay)

Some benefits, such as flexible scheduling, may cost nothing at all but still improve worker productivity.

Benefits are either mandated or optional.

Mandated benefits

Mandated benefits are required by law. Most of them are state or federal programs that employers participate in. Common ones include:

  • Social Security

  • Workers' compensation

  • Unemployment insurance

Optional benefits

Optional benefits are those that employers choose to offer their employees. The actual types of benefits are nearly limitless and may include very specialized ones that are unique to a company. But several are common to find among employers:

Are employee benefits taxable?

Many employee benefits are taxable, while others are nontaxable, partially taxable, or tax-deferred. The term tax-qualified refers to the fact that they benefit from some kind of tax advantage. Let's look briefly at each.

  • Taxable. If benefits are taxable, they will be included in employees' W2 forms as part of their wages. As such, they will be subject to federal taxes, Social Security taxes, and Medicare taxes.

  • Nontaxable. Benefits that are nontaxable will be excluded from gross wages before the wages get paid. This gives them the appearance of being pre-tax to the employee, though they are actually non-tax to the employee. The distinction is subtle. The benefits are tax-deductible to the employer instead. Health insurance is an example of a benefit that is commonly nontaxable.

  • Partially taxable. Partially taxable benefits are excluded from taxation only up to a certain amount of their value.

  • Tax-deferred. Tax-deferred benefits are not taxable when received, but will be taxable later on. Many retirement plan benefits, for example, are tax-deferred.

Any taxability of a benefit is reduced by any amount that an employee contributes to it. For example, a benefit with a value of $50 per month in which the employee contributes $30 will be taxed on only $20 of it.

A variety of rules and regulations apply to the tax issues of employee benefits. The IRS has guidelines to help you understand the hows and the whys of each type. The employer must also follow guidelines, and they usually include regulations from non-IRS federal agencies. They may also include state agencies.

Types of employee benefits

Employee benefits range from those that are very common and expected by employees to those that are unique to a company or very rare. Some benefits, such as life insurance and health insurance, exist in the form of group plans so as to get the lowest possible cost.

Here are the most common benefits that are available for the offering:

Health

Woman Having Eye Exam, Wellsville; New York; USA       . (Photo by: Education Images/Universal Images Group via Getty Images)
Vision insurance is a popular employee benefit. (Photo: Education Images/Universal Images Group via Getty Images)

Retirement

Family

  • Adoption assistance

  • Childcare assistance

  • Dependent care reimbursement accounts

Education

  • Education assistance programs

  • Onsite or online education programs

Personal

  • Counseling (personal, financial, etc.)

  • Paid leave/vacation/personal time/entertainment time/birthdays

  • Holiday pay

  • Recognition

  • Personal computers

  • Employee assistance programs

  • Life insurance

A woman uses her Apple iPhone and laptop in a cafe in lower Manhattan in New York City, U.S., May 8, 2019. REUTERS/Mike Segar
Employee benefits sometimes include a personal laptop. (Photo: REUTERS/Mike Segar)

Compensation

  • Stock options

  • Profit sharing

  • Direct deposit of paychecks

  • Non-performance bonuses

  • Performance incentives

Transportation

  • Transportation assistance (e.g., bus passes)

  • Take-home vehicles

  • Travel and accident insurance

Other

  • Food, beverages, and snacks

  • Telecommuting

  • Discounts on products or services, including the company's

  • Legal assistance

  • Housing

  • Flexible scheduling

Some benefits are provided immediately upon employment, while others require a probation period of weeks, months, or years. Profit sharing and stock options are examples of benefits that often require years of employment before receiving. Some, such as childcare assistance, are useful only to segments of a company's workforce, while others are useful to all employees.

At some companies, particularly the larger ones, benefits are offered via a cafeteria plan. That is a vernacular term describing an arrangement in which employees choose from a menu of benefits to form a benefit plan of their own.

Cafeteria plans

A cafeteria plan is an employee benefit arrangement that lets employees choose from a variety of benefits in order to craft a benefit plan that suits their needs. The name comes from the cafeteria-like manner of choosing benefits. It is also known as a Section 125 plan, or just 125 plan, after the section of the IRS code for which it is named.

What benefits are available?

Cafeteria plans can include a large number of benefits such as retirement plans, health insurance, disability insurance, vision and dental insurance, and group term life insurance. They can also offer flexible spending accounts, which reimburse qualified medical expenses. As well, they can even include cash benefits.

To qualify, a cafeteria plan must allow employees to choose from at least two different benefits that include cash or qualified plans. Qualified plans are those that receive tax advantages under IRS rules.

Cafeteria plans usually offer benefits during an enrollment period. An employee cannot normally change or add coverage during the plan year unless there is a change in his or her status (for example, a change in the number of dependents covered).

How are they paid for?

Most cafeteria plan benefits are pre-tax, meaning that they are paid with employees' earnings before they are taxed. Typically, they are taken out through payroll deduction. Although cafeteria plan benefits are normally pre-tax, there are also occasional situations where employees must report the benefits as income. One situation is when the plan discriminates in favor of highly compensated employees.

As with some other employee benefits, the question of who pays for them and how much varies. With insurance plans, for example, employees may be asked to pay for some of the cost.

Perspectives on cafeteria plans

Cafeteria plans tend to become more useful to employees as the number of employees grows and diversity increases. For example, the needs of a single person may differ from the needs of a family. The needs of a parent may differ from the needs of a non-parent. The needs of a 20-something employee may differ from those of a 60-something employee. The more diverse the workforce, the more benefits that can be offered.

A final word

Section 125 has been amended many times to address the needs of employees and may continue to be addressed as the needs of the workforce change. The IRS and the Treasury Department issue rules and regulations periodically that cover the various eligibility and tax issues.

Financial planning with your employee benefits

Benefits are a big part of many peoples' financial planning. Without benefits offered in the workplace, many people would not be prepared for retirement or health costs or many other life situations that arise.

Many employees have come to rely on these benefits in place of doing their own research, analyzing alternatives, or meeting with financial planners on their own.

Utilize the tax savings

Beyond financial security, many employee benefits are valuable for their tax-shielding ability. Retirement, medical, and insurance benefits provide some of these tax savings. You might consider how to handle the tax savings that you originally got from any tax-deferred benefits. They won't magically end up in your hands, so you must calculate what they actually are and then set aside that amount of money, perhaps in a special account for just this purpose, so that you can direct how it is used.

You, the financial planner

You still must do a certain amount of financial planning for your benefits. If insurance premiums rise, you might be asked to contribute more, so you may need to refigure how your coverage is set up. Can you afford to increase a deductible? Can you reduce coverage, and if so, do you have a way to pay for what is not covered in the event that something unfortunate happens? In cases like these, it may be helpful to set aside a separate fund or redirect a tax refund to build up money for just such a thing.

Another planning issue involves reimbursement plans, such as the popular flexible spending account. You must determine how much to put into the plan, which means you must accurately estimate what you will spend in the coming year on expenses. This can be hit or miss for some people, so it pays to plan your medical care to the extent possible.

Also, you must consider that in some cases, you may forfeit a portion of unused funds at the end of the year. Therefore, a certain amount of financial counseling may help you make the most of how you plan your benefits.

Drew Darmon (R) and his wife Erika Darmon (L) look on as they receive tax preparation assistance from a tax preparer. (Photo: Justin Sullivan/Getty Images)
Drew Darmon (R) and his wife Erika Darmon (L) look on as they receive tax preparation assistance from a tax preparer. (Photo: Justin Sullivan/Getty Images)

The downsides

Consider some downsides of your tax savings. The monthly payout that you get from Social Security at retirement is based upon your earnings during your working years. Redirecting wages during your working years into an employee benefit plan can shield it from taxes, but this may result in a slightly lower benefit at retirement.

And funds paid out of a benefit plan for dependent care costs interfere with your ability to take the child care credit on your tax return. In these cases, you might sit down with a counselor or financial planner and do some math to determine how to get the most out of the money you are spending.

Although company benefits can put our minds at ease, sometimes we get the nagging feeling that they are not competitive with what's out there. Is your company's health insurance plan better than one that you could buy on your own—even an individual one? What about its life or disability insurance? In these cases, some research on your part might uncover better deals outside your company.

Summary of employee benefits programs

Employee benefits have gone a long way toward building the American workforce. They have attracted and kept talent. They have made companies attractive to work for. The federal government has sweetened the deal by offering tax incentives that serve both employers and employees.

Employees, for their part, have used benefits to increase their quality of life and prepare for the risks that befall many of us. As an educated investor, you can increase your takeaway by learning how your benefits work. The difference could be thousands of dollars and many missed opportunities. Luckily, many companies have human resources specialists to help you get the most out of your benefits.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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