What Is Section 125?
Section 125 is an IRS approved way for employers
and their employees to change and personalize their benefits while controlling
plan costs. Employees can use pre-tax dollars to pay for certain benefits
, thus reducing their taxable income and taxes.
How It Works
Without a Section 125 plan, employees pay for their portion of employee benefit costs with dollars they have already paid taxes on (after tax dollars). With a 125 plan, employees can pay most of these costs with pre-tax dollars.
Immediate Tax Savings
Employee contributions to the 125 plan lowers wages subject to federal income tax. This produces an immediate income tax savings. In most cases state and local income taxes, as well as employee social security taxes are reduced.
Social Security Benefits Impact
Since reducing taxable wages means a reduced
social security tax, future social security benefits may decline. For this
reason, it is recommended that the participants' tax savings be transferred to a
savings or investment plan. Typically the savings or investment plan will
provide from five to ten times the retirement income of the reduction in social
Section 125 plans may begin at any time. Immediate employer action may mean significant savings since participating employers usually save 10% of the amount of payroll reallocated to a 125 plan.
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