A Section 125 Cafeteria Plan is a benefits plan employers can offer that allows employees to assign a portion of their pre-tax income to accounts for specific purposes, such as health care, dependent care and even adoption assistance, according to the IRS. There are limitations on how much income can be assigned to these plans and for what purposes.
Pro: Lowers Taxable Income
A Section 125 Cafeteria Plan, such as a dependent care flexible spending account (FSA), lets an employee designate a certain amount of money to come out of each paycheck for deposit in an account that can be used to pay for daycare, as an example. The result is that you have the money for expenses you would incur anyway, but at tax time your W-2 will show a slightly lower taxable income because the money that went into the FSA isn't taxable, the IRS reports. The result should be a slightly lower tax bill.
Con: Use It or Lose It
This is probably the single biggest con of Cafeteria Plans such as FSAs. For example, if you earmark $5,000 for healthcare expenses at the beginning of the year, but then don't use all of it, you lose whatever is left in the FSA when the year ends, the Total Administrative Services Corporation says.
Pro: Flexibility
Most Cafeteria Plans give employees freedom to choose their service providers, the IRS says. As long as the expenses can be verified and fall under the terms spelled out in your plan--you will probably have to provide the Tax Identification Number of the daycare center you're using, for example--you can choose a provider that fits your needs. Likewise, some Cafeteria Plans allow employees to pay for group term life insurance. Choosing the insurer and the details of the policy are up to the employee.
Con: Expenses Must Be Reimbursed
Unfortunately, you can't get an "advance" on money in your Cafeteria Plan. After you incur medical or dependent care expenses, you must fill out the paperwork and request a reimbursement. There can be a lag time, depending on how efficient your program is, and the burden to get your money back is absolutely yours alone.
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