A Section 125 Plan is a great program that allows employees to purchase certain eligible benefits on a pre-tax basis. Regularly reviewing your plan to ensure it is compliant with Internal Revenue Code (IRC) regulations will help it remain a valuable part of your employees’ overall benefit package. Here are the areas of your plan that should be reviewed regularly by you and your legal advisor:

Plan Document

Your Section 125 plan must be in writing and must operate in accordance with its written plan. The document should be reviewed periodically by the employer, and any changes should be made and be finalized in writing. In particular, you should verify the following items are correct in the plan document:

  • Plan year,
  • Insurance benefits, carriers, and descriptions,
  • Eligibility of the insurance benefits offered under the plan,
  • Eligibility requirements for participation in the plan,
  • Flexible Spending Account (FSA) minimum and maximum contributions (if offered),
  • Non-elective (employer) contributions and elective (employee) contributions.

Plan Design

A Section 125 Plan must offer a choice between at least one taxable benefit (such as salary) and one qualified benefit (such as major medical coverage). A plan that does not offer this choice is not a Section 125 Plan and may be disqualified by the Internal Revenue Service (IRS) in the event of an audit. The plan must only offer eligible benefits as defined by IRC regulations. These include major medical plans (insured plans, HMOs, PPOs, high deductible health plans, and self-insured plans), dental plans, vision plans, cancer coverage, disability coverage (long and short-term), and certain term life insurance. It could also include Flexible Spending Accounts (FSAs) such as a Health Flexible Spending Account (Health FSA), Dependent Day Care Flexible Spending Account (Dependent Day Care FSA), as well as Health Savings Accounts (HSAs).

Offering benefits, other than eligible benefits, is not allowed. You also should have signed election forms for each employee that either shows the benefits elected under the 125 Plan or that the employee is waiving participation under the 125 Plan. The 125 Plan design must also follow specific terms included in the document, such as those pertaining to the Health FSA grace period (if offered) and eligible mid-plan year election changes.

FSA Requirements

A Section 125 Plan that offers one or more FSAs must follow the rules established for those accounts. This includes the “uniform coverage” rule which states that a participant’s full Health FSA annual election must be made available to him or her throughout the plan year regardless of the amount of contributions made to the account. It must also include the “use-or-lose” rule, which requires unused elected amounts be forfeited at the end of the plan year.

You may also choose to offer the carryover provision or a grace period for your Health FSA. The carryover provision allows employees to carry over up to $500 of unused contributions into the next plan year. A grace period allows employees a period of time after the plan year ends to continue incurring expenses to be reimbursed from the remaining balance of the previous year's Health FSA contributions. The carryover provision and the grace period are exceptions to the “use-or-lose” rule associated with the account. An employer is also restricted on the use of any FSA forfeitures. Using FSA forfeitures other than as expressly allowed in the IRC Regulations could cause the Section 125 Plan to be out of compliance.

The regulations also require that FSA claims meet specific eligibility requirements and must be properly substantiated. The employer's Section 125 Plan cannot allow claims to be reimbursed that were incurred prior to the FSA’s period of coverage.

American Fidelity Can Help with Section 125 Compliance

If you would like assistance creating and maintaining your Section 125 Plan, American Fidelity can help. When you choose us as your provider, we will help you properly implement and maintain your Plan, including the Plan Document. We will provide a sample document containing your specific Plan information for your approval. American Fidelity will also assist with gathering election forms for employees and new hires year round.  

For more information, contact your local American Fidelity account manager.  

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