VISIT OUR HOME PAGE

FLEXIBLE COMPENSATION AND CAFETERIA PLANS

I. The Objective of Flexible Compensation
 

A. Flexible Compensation allows an employee to decide upon his own employee benefit package. It is presumed that with individual employee choice each employee will fashion an employee benefit program which will maximize his satisfaction. Thus, an employer will theoretically get more for its money with a flexible benefits package.
 

B. Within certain statutory constraints, flexible compensation allows an employee to divert salary to employee benefits on a pre-tax basis. An employee is able to utilize pre-tax dollars to pay his share of any insurance premiums, to pay deductibles and coinsurance amounts under health benefit plans, or to pay medical bills, such as orthodontia, which may not be covered by the employer's plan.
 

C. Flexible benefit packages have been utilized by employers as vehicles to get away from providing extremely expensive employee benefit plans to all employees. They have also been a way for an employer to introduce new benefits such as dependent care benefits or dental coverage without increasing its overall cost.
 

II. Types of Flexible Benefits or Cafeteria Plans
 

A. The following sets forth the major types of Flexible Benefits or Cafeteria Plans being used by employers today:
 

1. Pre-Tax Conversion Plan - a plan where the employees are covered by a contributory medical plan. Instead of the employee contributions being after- tax, the employee contributions are converted to pre-tax by complying with the rules of Internal Revenue Code Section 125 on cafeteria plans.
 

2. Multiple Option Pre-Tax Conversion Plan - a program where the employee can select an indemnity plan and one or more HMOs or PPOs with differing amounts of employee contributions. If the program complies with Code Section 125, the employee contributions to the selected plan will be pre-tax rather than after-tax. If the participant chooses not to participate in any medical plan, the employee does not receive any payments from the employer but does get to keep his own money.
 

3. Medical Plan Plus Flexible Spending Accounts - In addition to being covered by a medical plan, the employer allows participants to establish a medical flexible spending account. In most cases, the contributions to a flexible spending account are exclusively from the employee on a pre-tax salary reduction basis. The amounts credited to a flexible spending account are then used to pay amounts which are not covered by the medical plan such as deductibles, co-insurance amounts or cosmetic surgery. In addition, the employer can provide an option to have salary reduction amounts contributed to a Dependent Care flexible spending account.
 

4. Employer Credit Cafeteria Plans - a program where the employer gives the employee a specified number of credits which the employee can "spend" on different employee benefit plans or contribute to a flexible spending account. Usually, there are sufficient employer credits for an employee to choose a low-cost medical plan and a base amount of life insurance coverage without requiring the employee to contribute his own money. To the extent that the employee chooses a more costly benefit package, he will have to make contributions out of his own money, usually through a pre-tax conversion feature. These plans can be divided into two types:

a. those which allow an employee to elect not to be covered by any medical plan; and

b. those which do not allow an employee "to go naked."
 

III. Cafeteria Plans Under IRC § 125
 

A. Definition of a Cafeteria Plan
 

1. A cafeteria plan is a plan under which employees are provided with the opportunity of choosing between one or more employee benefits and cash. IRC § 125(d)(1)(B).
 

2. Under the definition of a cafeteria plan, one of the options under the plan must be the option to receive cash compensation. IRC § 125(d)(1)(B) as amended by the Technical and Miscellaneous Revenue Act of 1988 § 1011B(a)(12).
 

3. A cafeteria plan must be limited to common-law employees. It is not possible to have a cafeteria plan for partners or self-employed individuals. Prop. Treas. Reg. § 1.125-1 Answer 4.
 

4. A cafeteria plan can cover former employees as long as the predominant group of participants are active employees. Prop. Treas. Reg. § 1.125-1 Answer 4. It is not clear whether a former employee can elect between nontaxable employee benefits and taxable retirement benefits as a part of a cafeteria plan although the IRS has informally stated that such an election will not be permitted.
 

5. The plan cannot provide for deferred compensation other than a 401(k) plan. Life insurance products which involve the build up of cash values or investment accounts cannot be included in a cafeteria plan. Prop. Treas. Reg. § 1.125-2 Answer 5.
 

6. The prohibition on deferred compensation has prompted the IRS to rule that amounts held pursuant to a cafeteria plan cannot be carried over into a subsequent year. Thus, any amounts which are allocated to be used to pay medical expenses must be used for medical expenses during the plan year or they must be forfeited--a "use it or lose it" rule. Prop. Treas. Reg. § 1.125-2 Answer 5(a).
 

7. The plan cannot include long-term care insurance as one of its options. IRC § 125(f) as amended by § 321 of the Health Insurance Portability and Accountability Act of 1996 ("HIPAA").
 

8. The plan must be in writing and contain the following provisions:

a. A description of the benefits available under the plan;

b. The periods of coverage for each benefit provided under the plan;

c. The plan's eligibility rules;

d. The plan's rules for making elections including the period for making elections, the period during which the elections are effective and the rules for the revocation of elections;

e. The plan's provisions relating to contributions including employer contributions and salary reduction contributions by the participants; and

f. The plan year.
 

B. Flexible Spending Accounts Under a Cafeteria Plan
 

1. Benefits under a cafeteria plan need not be employer provided benefits. They can be uninsured, pay as you go benefits handled through a flexible spending account.
 

2. A flexible spending account is a bookkeeping account to which the employee elects to have cash amounts credited. The amounts credited to the spending account can either be employer contributions or salary reduction amounts elected by the employee. The amounts contributed by the employee must be more than 20% of the total amounts credited to the flexible spending account. Prop. Treas. Reg. § 1.125-2 Answer 7(c).
 

3. The amounts credited to the flexible spending account can be used during the coverage period, usually the plan year, to pay the out of pocket medical or dependent care expenses which the participant would otherwise have to pay. Expenses incurred after the end of the coverage period cannot be paid from the amounts contributed to the flexible spending account during the period. Prop. Treas. Reg. § 1.125-2 Answer 7(b)(6).
 

4. The advantage to the employee of participating in a flexible spending account is that, if the employee funds the account with pre-tax salary reduction contributions, the employee is using pre-tax dollars to pay out of pocket expenses which would normally be paid with after-tax dollars.
 

5. Amounts contributed to a flexible spending account must either be used to provide benefits, such as medical or dependent care benefits, or must be forfeited--the "use it or lose it" rule. Prop. Treas. Reg. § 1.125-2 Answer 5(a).
 

6. If an employee elects salary reduction in order to fund a medical flexible spending account, proposed regulations would require that the amount of the salary reduction for the entire plan year must be available to pay benefits from the account as of the first day of the plan year. Thus, if an employee elects to have his salary reduced by $100 per month for payment of medical bills, his flexible spending account must be credited with $1,200 as of the first day of the plan year. This requirement does not apply to dependent care flexible spending accounts.
 

NOTE: The employer could lose money with respect to the employee if he uses up his account and then leaves during the middle of the year. This seems to be the reciprocal of the "use it or lose it" rule where the employer profits from the employees who do not use up their full spending accounts. Prop. Treas. Reg. § 1.125-2 Answer 7(b)(2). To the extent permitted by state law, one solution would be to provide for the reduction of any final salary check payable to the terminated employee in the amount of the balance of the salary reduction contributions due from the employee.
 

7. Spending accounts for medical benefits must be kept separate from spending accounts for dependent care benefits. Prop. Treas. Reg. § 1.125-2 Answer 7(b)(4) and (8).

8. The period for coverage by a flexible spending account and the period for salary reduction contributions must generally be at least 12 months except for a short plan year or the failure of the employee to make contributions. Prop. Treas. Reg. § 1.125-2 Answer 7(b)(3).
 

9. The proposed regulations would require that the flexible spending account must provide for two levels of substantiation of amounts reimbursed from a flexible spending account:

a. there must be a written statement from an independent third party that the medical expense was incurred and the amount of the medical expense--a copy of the bill for the services or product should satisfy this requirement; and

b. the participant must provide a written statement that the expense has not been reimbursed and is not eligible for reimbursement under any other health coverage. Prop. Treas. Reg. § 1.125-2 Answer 7(b)(5). The plan's claim form should incorporate the language necessary to satisfy this requirement.
 

10. A medical expense flexible spending account cannot be used to pay the premiums for health insurance including health insurance provided by the employer or the spouse's employer. Prop. Treas. Reg. § 1.125-2 Answer 7(b)(4). This requirement seems to be unnecessary with respect to the premiums payable under the health insurance program of the participant's employer. These premiums can be paid under a cafeteria plan through salary reduction and, as a result, the participant can get the same tax benefit as though they were paid from the flexible spending account.
 

11. COBRA continuation of a flexible spending account.

a. Normally, the COBRA provisions require that a qualified beneficiary or participant be allowed to continue to participate in an employer's medical benefits plan or insurance for a period of 18, 29 or 36 months after the date coverage would otherwise end.

b. These rules have been modified with respect to a flexible spending account so that continuation of a flexible spending account is only required when it makes economic sense for the qualified beneficiary.

i. That is, if the required payments for the remainder of the current year equal or exceed the potential payments of benefits for the remainder of the year, then continuation of the flexible spending account is not required. Treas. Reg. §54.4980B-2 Answer 8(b)-(e) Thus, only if the qualified beneficiary has paid more in contributions to the flexible spending account during the period prior to the qualifying event than the qualified beneficiary has received in benefits prior to the qualifying event will the employer be required to allow the qualified beneficiary to continue to contribute to the account.

ii. In addition, because the qualified beneficiary would, under COBRA have to contribute 102% of any benefits to which he would be entitled in any subsequent year and because such contributions would be after tax, it does not make economic sense for the qualified beneficiary to participate in the flexible spending account in any year after the year during which the qualifying event occurred. Thus, COBRA does not require that the flexible spending account be offered in any year subsequent to the year in which the qualifying event occurred. Treas. Reg. 54.4980B-2 Answer 8(b)-(e).
 

C. Allowable Benefits Under a Cafeteria Plan
 

1. A cafeteria plan can include one or more of the following benefits:

a. disability, accident and sickness benefits under IRC § 105 and 106, other than a medical savings account described in IRC § 106(b) and other than long-term care benefits, IRC 125(f) as amended by § 321 of HIPAA;

b. group term life insurance under IRC § 79;

c. dependent care assistance plans under IRC § 129;

d. adoption assistance under IRC § 137;

e. 401(k) plans including IRC § 401(m) contributions under a 401(k) plan;

NOTE: It accomplishes little to include a 401(k) plan in a cafeteria plan since salary reduction contributions to a 401(k) plan are nontaxable in any event without the operation of IRC 125.

f. vacation pay; and

g. cash.
 

2. The following benefits cannot be provided as a part of a cafeteria plan:

a. Scholarships and fellowships which are nontaxable by reason of IRC § 117;

b. Certain fringe benefits which are nontaxable under IRC § 132;

c. Meals and lodging provided to employees for the convenience of the employer which are nontaxable under IRC § 119;

d. Medical savings accounts which are nontaxable under IRC § 106(b); and

e. Long-term care insurance contracts which are nontaxable under IRC 106(a) and IRC § 7702B(a)(1).
 

3. Benefits under a cafeteria plan must meet both their own coverage and nondiscrimination requirements, if any, and special cafeteria plan coverage and nondiscrimination requirements contained in IRC § 125(b)(1):

a. the plan must benefit a classification of employees which does not discriminate in favor of highly compensated employees, IRC § 125(g)(3)(A);

b. the plan cannot include an eligibility requirement which requires more than three (3) years of service for participation, IRC § 125(g)(3)(B)(i);

c. employees must become participants no later than the first day of the plan year following the completion of the service requirement for eligibility, IRC § 125(g)(3)(B)(ii);

d. Except for a cafeteria plan maintained pursuant to a collective bargaining agreement, both the availability of benefits and the selection of the total benefits and the nontaxable benefits under a cafeteria plan must not discriminate in favor of highly compensated employees, Prop. Treas. Reg. § 1.125-1 Answer 19; and

e. Under IRC § 125(b)(2) no more than 25% of the statutory nontaxable benefits of a cafeteria plan can benefit key employees as defined in the top heavy provisions of IRC § 416.

f. A health benefit plan offered under a cafeteria plan will not be deemed to be discriminatory if the contributions for each participant includes an amount which either:

i. equals 100% of the cost of the health benefit option which is selected by a majority of the highly compensated employees; or

ii. equals 75% of the cost of the health benefits of the participant who has the health coverage having the greatest cost.

g. Contributions to a health plan in excess of the amounts specified in paragraph f above can bear a uniform relationship to the compensation of the participants.
 

D. Employee Benefit Elections Under a Cafeteria Plan

1. Employee benefit elections must be made prior to a period of coverage-- generally the plan year;
 

2. The elections must be irrevocable once the coverage period begins except that the plan can allow a participant to change his election in the event of certain changes in family status provided that the change in election is consistent with the change in family status.
 

3. Prior to January 1, 2001, the plan could elect to be covered by pre-1997 proposed regulations, certain 1999 temporary and proposed regulations, or final and proposed regulations issued March 23, 2000 as follows:

a. The pre-1997 proposed regulations generally allowed changes in all benefits under a cafeteria plan in the event of:

i. marriage of the participant;

ii. divorce of the participant;

iii. death of a covered family member;

iv. termination of employment of the participant's spouse;

v. birth or adoption of a child; or

vi. other family changes causing a major change in the participant's employee benefit needs. Prop. Treas. Reg. § 1.125-2 Answer 6(c).

b. The 1999 Temporary and Proposed Regulations split the provisions on changes in family status into two parts, one relating to changes in health, accident and group term life insurance coverages and the other relating to all other benefits under a cafeteria plan:

i. Health, accident and group term life insurance benefits can be changed in the following events:

(A) health and accident coverage can be changed in any situation which triggers special enrollment rights under the Health Insurance Portability and Accountability Act as set forth in Code § 9801(f).

(B) changes in the participant's legal marital status, including:

(I) marriage of the participant;

(II) divorce of the participant;

(III) death of the spouse of the participant;

(IV) legal separation of the participant; or

(V) annulment of the participant's marriage.

(C) Changes in the number of the participant's dependents; including:

(I) birth of a dependent;

(II) adoption of a dependent;

(III) placement for adoption of a dependent in the participant's home; or

(IV) death of a dependent;

(D) A termination or commencement of employment of the participant, the participant's spouse, or a dependent;

(E) A reduction or increase in the number of hours worked by the participant, the participant's spouse, or a dependent including:

(I) a change from part-time to full-time status or from full-time to part-time;

(II) a strike or lock-out;

(F) commencement or return from an unpaid leave of absence;

(G) A dependent satisfying or ceasing to satisfy the requirements of the applicable plan for dependent coverage; or

(H) A change in the residence or worksite of the participant, the participant's spouse, or a dependent. Temp. Treas. Reg. § 1.125- 4T(c)(2).

ii. With respect to benefits other than health, accident and group term life insurance, a change in family status continues to be defined under the pre-1997 proposed regulations. Prop. Reg. § 1.125 - 2 Answer 6(c). See § III.D.3.a above.

c. Under the final and proposed regulations issued March 23, 2000, the dichotomy between health, accident and group term life insurance will end as follows:

i. Health, accident and group term life insurance benefits can be changed in the following events:

(A) any situation which triggers special enrollment rights under the Health Insurance Portability and Accountability Act as set forth in Code § 9801(f);

(B) changes in the participant's legal marital status, including:

(I) marriage of the participant;

(II) divorce of the participant;

(III) death of the spouse of the participant;

(IV) legal separation of the participant; or

(V) annulment of the participant's marriage.

(C) Changes in the number of the participant's dependents; including:

(I) birth of a dependent;

(II) adoption of a dependent;

(III) placement in the participant's home of a dependent for adoption; or

(IV) death of a dependent;

(D) changes in the employment status of the participant, the participant's spouse, or a dependent, including;

(I) A termination or commencement of employment;

(II) a strike or lock-out;

(III) commencement or return from an unpaid leave of absence; and

(IV) a change in worksite;

(E) any change in category of employment which results in a change in the eligibility of the participant, spouse or dependent for the employee plan of his or her employer;

(F) A dependent satisfying or ceasing to satisfy the requirements of the applicable plan for dependent coverage; or

(G) A change in the residence of the participant, the participant's spouse, or a dependent. Treas. Reg. § 1.125-4.

ii. With respect to benefits other than health, accident and group term life insurance, a change in status will be determined under the same rules as for health, accident and group term life insurance benefits. Reg. § 1.125 - 4(c)(1)(iii).
 

4. Beginning January 1, 2001, the final regulations issued March 23, 2000 and January 10, 2001 are largely in effect. As noted above, these rules will end the dichotomy between health, accident and group term life insurance continues as follows:

a. Health, accident and group term life insurance benefits can be changed in the following events:

i. any situation which triggers special enrollment rights under the Health Insurance Portability and Accountability Act as set forth in Code § 9801(f);

ii. changes in the participant's legal marital status, including:

(A) marriage of the participant;

(B) divorce of the participant;

(C) death of the spouse of the participant;

(D) legal separation of the participant; or

(E) annulment of the participant's marriage.

iii. Changes in the number of the participant's dependents; including:

(A) birth of a dependent;

(B) adoption of a dependent;

(C) placement in the participant's home of a dependent for adoption; or

(D) death of a dependent;

iv. changes in the employment status of the participant, the participant's spouse, or a dependent, including;

(A) A termination or commencement of employment;

(B) a strike or lock-out;

(C) commencement or return from an unpaid leave of absence; and

(D) a change in worksite;

v. any change in category of employment which results in a change in the eligibility of the participant, spouse or dependent for the employee plan of his or her employer;

vi. A dependent satisfying or ceasing to satisfy the requirements of the applicable plan for dependent coverage; or

vii. A change in the residence of the participant, the participant's spouse, or a dependent. Treas. Reg. § 1.125-4.

b. With respect to benefits other than health, accident and group term life insurance, a change in status will be determined under the same rules as for health, accident and group term life insurance benefits. Reg. § 1.125 - 4(c)(1)(iii).
 

5. Changes are also permitted if there has been a significant change in the coverage of the participant, his or her spouse or dependents because of a change in the benefit plan covering the spouse at his or her place of employment. Prop. Treas. Reg. § 1.125 - 2 Answer 6(b) and Treas. Reg. § 1.125 - 4(f).
 

6. An election can also be changed in the middle of the coverage period in the event there is a significant change in the cost of the benefit as a result of a cost increase. Prop. Treas. Reg. § 1.125 - 2 Answer 6(b)

a. See also Treas. Reg. § 1.125 - 4(f) which eliminated the need that the cost increase be imposed by an unrelated third party provider except in the case of dependent care being provided by a relative.

b. Health benefits flexible spending account elections cannot be changed simply because of a cost increase. Prop. Treas. Reg. § 1.125 - 2 Answer 6(b) and Treas. Reg. § 1.125 - 4(f).
 

7. An election can be changed if the coverage being provided to the participant is significantly curtailed or terminated. Prop. Treas. Reg. § 1.125-2 Answer 6(b)(2). See also Treas. Reg. § 1.125-4(f) which eliminated the requirement that the curtailment be made by an independent third party provider.
 

8. A participant can elect to cease participating in a cafeteria plan if his employment is terminated and the plan so provides. Participants who so elect and are subsequently rehired can rejoin the plan. Treas. Reg. § 1.125-4(c)(2)(iii) and § 1.125-4(c)(4) Examples 7 and 8.

Note: Because of the requirement that a participant be credited with the full amount of his salary reduction amount for the full plan year on the first day of the plan year, it may not make sense to allow participants to elect to discontinue coverage when they terminate employment. Since the participant may have had medical expenses which equaled the full year's salary reductions prior to the date of his termination of employment, it might make more sense to require the participant to continue in the plan and to complete his contributions.
 

9. The restrictions on changes in elections under a cafeteria plan do not apply to elections of salary reduction or after tax contributions under a 401(k) plan. Changes in such elections can be made in accordance with the normal rules applicable to 401(k) plans.

E. Vacation Days Included in a Cafeteria Plan
 

1. Vacation days can be included in a cafeteria plan. That is, a participant can elect between additional vacation days and other permitted benefits under the plan.
 

2. To the extent that a participant elects vacation days under a cafeteria plan, he must use them before the earlier of the end of the plan year or the end of his taxable year or they must be forfeited -- another form of "use it or lose it." Prop. Treas. Reg. § 1.125-2 Answer 5(c)(3).
 

3. In lieu of using an elective vacation day, a participant can elect to cash it out provided that the vacation day is cashed out before the earlier of the end of his taxable year or the end of the plan year. Prop. Treas. Reg. § 1.125-2 Answer 5(c)(3).
 

4. In determining if a participant has used his elective vacation days, he is deemed to use any nonelective vacation days first and the elective vacation days last. Prop. Treas. Reg. § 1.125-2 Answer 5(c)(2).
 

F. Cafeteria Plans and the Family and Medical Leave Act
 

1. The Family and Medical Leave Act ("FMLA") entitles the employees of certain employers to have 12 weeks of unpaid leave for certain family or medical reasons.
 

2. In the event of an unpaid leave under The Family and Medical Leave Act, the participant must be provided with the election of whether to continue to have, or to suspend, medical coverage during the leave.
 

3. If an employee elects to discontinue health plan coverage during an FMLA leave or if his health plan coverage was discontinued because of non-payment of premiums, the employer must offer the employee the right to reinstate the coverage upon his return to work at the end of the FMLA leave. Such reinstated coverage would be on the same basis as the employee's coverage prior to the FMLA leave unless a change in family status has occurred.
 

4. If the employee elects to continue health plan coverage during the FMLA leave, the employee must pay the same portion of the premiums for the coverage which he was paying prior to the FMLA leave with the balance of the premium continuing to be paid by the employer.
 

5. The employer may give the employee one or more of the following options of continuing to pay the employee's portion of the premium:

a. Pay-as-you-go: The employee would pay the employee portion of the premium on a periodic basis.

b. Pre-payment: The employee would pay the employee portion for the entire FMLA leave in advance; or

c. Catch-up payment: The employee would pay the employee portion at the end of the FMLA leave.
 

6. The alternatives relating to the methods of payment are subject to the following rules:

a. The employer cannot offer the pre-payment option as the only form of payment;

b. The employer cannot offer the catch-up payment option as the only form of payment unless that is the only form of payment offered to other persons on other unpaid leaves of absence; and

c. The employer cannot offer the employee on an FMLA leave of absence a choice between the pre-payment option and the catch-up payment option without the pay-as-you-go option unless they are the only two options offered to employees on other unpaid leaves of absence.

Note: Because of the rules, in most cases employers will have to offer the pay-as-you-go option and may or may not offer one of the other two options.
 

7. The employer can voluntarily waive the payment of premiums by an employee on an FMLA leave of absence if it chooses.
 

8. A health flexible spending account is treated the same way as any other health plan during an FMLA leave of absence. Thus, the employee must be given the option of dropping coverage during the leave and having the coverage reinstated upon his return to work. Prop. Treas. Reg. § 1.125-3.
 

G. Plan Asset Regulations and Cafeteria Plans
 

1. The DOL finalized regulations on employee contributions to plans covered by ERISA on May 17, 1988. Under the regulations, an employer is required to segregate employee contributions from the assets of the employer at the earliest practicable date. DOL Reg. § 2510.3-102(a). On August 7, 1996 the DOL clarified this requirement so that the latest date that the employer can hold employee contributions and salary reductions for a pension benefit plan is the 15th business day of the month following the month in which such employee contribution or salary reduction would otherwise have been paid. DOL Reg. § 2510.3-102(b). In contrast, an employer can hold employee contributions or salary reduction amounts for other benefit plans for 90 days after the date they would have otherwise been paid to the employee. DOL Reg. §2510.3-102(c).
 

2. Employee contributions which are plan assets must be held in trust or pursuant to an insurance contract. DOL Reg. § 2510.3-102(a).
 

3. ERISA Technical Release 88-1 was issued by the DOL clarifying that salary reduction contributions to a cafeteria plan were plan assets and subject to the trust requirement of ERISA. The DOL indicated, however, that no enforcement action would be taken with respect to salary reduction contributions to a cafeteria plan until further notice from the DOL.
 

4. The DOL supplemented its rulings on cafeteria plans on June 2, 1992 when it issued ERISA Technical Release 92-01. In ERISA Technical Release 92-01, the DOL clarified that:

a. the requirement to file an annual report will not apply to cafeteria plans with less than 100 participants; and

b. in the case of cafeteria plans having more than 100 participants, the audit requirement of ERISA § 103(a)(3) would not apply.
 

5. The problem with the DOL regulations is that, if the flexible spending accounts contained in a cafeteria plan are funded by a trust, the trust would likely be taxable to the participant under IRC § 83.
 

H. Consequences of Failure to Comply with Cafeteria Plan Rules
 

1. If a cafeteria plan is discriminatory within the definition of IRC § 125(b), the highly compensated employees will be taxed on the amounts which they could have received in cash or in the form of taxable benefits; or
 

2. If a cafeteria plan fails any other rule contained in IRC § 125 or the applicable Treasury regulations, all employees will be taxed on the amounts which they could have received in cash or in the form of taxable benefits.
 

IV. Other Flexible Compensation Programs
 

A. An employer can provide an employee with an election between two nontaxable benefits. Since neither benefit is taxable and cash is not an option, there is no constructive receipt and the employee is not taxed on the value of the benefit selected. For example, suppose an employee is given an election to be covered by an HMO or conventional indemnity health insurance with the premiums being paid by the employer. Since employer contributions to both an HMO or health insurance are not taxable to the employee, the election need not comply with the cafeteria plan rules.

B. Flexible Retirement Plans and Programs

1. There are a number of flexible retirement programs including:

a. 401(k) plans;

b. 403(b) annuities for certain tax exempt entities;

c. Simplified Employee Pension Plans under IRC § 408(k);

d. Simple retirement accounts under IRC § 408(p);

e. Deferred compensation programs for governmental entities and certain tax exempt organizations under IRC § 457; and

f. Non-qualified deferred compensation plans for a select group of management or highly compensated employees.
 

2. The only flexible retirement plan which can be combined with a cafeteria plan is a 401(k) plan. Neither 403(b) annuities nor 457 deferred compensation can be included in a cafeteria plan.