Glossary

Section 125 plan

An employer cafeteria plan under IRC section 125 that lets employees pay for benefits such as health premiums with pre-tax pay instead of taxable cash.

Also called: cafeteria plan, Section 125 cafeteria plan, premium-only plan, POP, flexible benefits plan

A Section 125 plan, or cafeteria plan, lets employees choose between taxable cash and certain qualified benefits. When they choose benefits, the amount comes out of pay before federal income tax and payroll taxes, so both employee and employer save on Social Security and Medicare tax. The simplest version is a premium-only plan, which lets employees pay their share of group health premiums pre-tax. Fuller plans add health and dependent care flexible spending accounts.

For 2026 the health FSA salary-reduction limit is $3,400, with a carryover of up to $680 if the plan allows it, and the dependent care FSA limit is $7,500, or $3,750 for married filing separately (IRS Rev. Proc. 2025-32; Publication 15-B).

The rules are strict. A written plan document is required, and without one the pre-tax treatment can be lost. Elections are made before the plan year and are irrevocable during it unless a permitted change in status or life event occurs and the plan allows the change. The plan must pass nondiscrimination tests, including that key employees receive no more than 25% of total benefits; a premium-only plan is generally deemed to meet the contributions, benefits and key-employee tests if it meets the eligibility test.

The common failure is paperwork: payroll deductions taken pre-tax with no adopted plan. The guide on Section 125 cafeteria plans: premium-only plans, FSAs and 2026 limits covers setup, and the health reimbursement arrangement and health savings account entries cover the accounts that sit alongside it.

Last reviewed October 10, 2026

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Related terms

Health reimbursement arrangement (HRA) An employer-funded plan that reimburses employees tax-free for medical expenses and, in some versions, individual health insurance premiums. Health savings account (HSA) A tax-advantaged personal account for medical costs that is open only to people enrolled in a qualifying high-deductible health plan. QSEHRA An employer-funded account for businesses under 50 full-time equivalent employees that reimburses workers for premiums and medical costs up to an annual cap. ICHRA An employer-funded account that reimburses employees tax-free for individual health insurance premiums they buy themselves, with no federal dollar cap. ERISA The 1974 federal law setting fiduciary, reporting and disclosure standards for private-sector retirement and welfare benefit plans, enforced by the DOL.

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