A Section 125 cafeteria plan allows an employee to:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Under IRC Section 125, a cafeteria plan lets employees choose between cash and qualified benefits. If the employee elects health coverage, their premium contribution is deducted from wages before federal income and payroll taxes are calculated, lowering taxable income. This group-market design makes coverage more affordable and is a common element of the consumer-directed, pretax benefit structures tested in the group medical expense domain. Cafeteria plans also let employees choose among other qualified benefits beyond health coverage, such as dependent care.
Why the other options are wrong
- B) The employee still pays the premium — the advantage is that the contribution is pre-tax, not that the premium disappears. The premium is still paid; only the tax treatment of it changes.
- C) A cafeteria plan is a benefit election structure, not a conversion device; converting coverage into an HSA involves different rules and contributions. Conversion to an HSA follows its own statutory rules.
- D) Taking cash from the cafeteria plan means the amount is treated as taxable wages; the tax break exists only when qualified benefits are selected. Cash is always taxable wages under a Section 125 plan.
Memory hook
Section 125 = pay your health premium before the tax man takes his cut. Cash out of the menu is always taxed.