Implementing a Cafeteria-Style Benefits Plan

Last Updated May 29, 2007 7:09 PM EDT

Because individual employee needs differ greatly, and because business competition demands across-the-board cost reductions, a flexible approach to benefits promises to satisfy both needs. While salary figures may attract employees, the right combination of benefits helps retain them.

Almost all employers offer some benefits to employees: medical insurance, paid vacations, and 401(k)s are the most common. The collective value of these benefit programs may or may not meet each person's needs. One rather elegant solution is to monetize the value of the benefits package and allow employees to pick and choose from a menu of options (hence the name cafeteria plan) to the extent of the dollar amount given to them. This flexibility is a powerful incentive for many employees with specific personal needs that can be met when plans are diverse enough.

What You Need to KnowWhat does the "menu" look like?

Basically, cafeteria plans offer a wide array of benefits that is limited only by the imagination. The menu could include a medical, dental, 401(k) and a number of paid vacation days. That is standard. But there are so many possibilities, when used, employee satisfaction increases because benefits more precisely meet their needs. For example, say an employee already has health benefits under his wife's plan, he would rather not pay for redundant coverage, but, perhaps, want a long-term disability program, life insurance or extra vacation days. So, for that employee, the cost of medical coverage could be used to purchase a different benefit.

In creating a cafeteria plan, the employer must determine which benefit costs will be paid by the company and which will be paid on a "co-pay" basis, or entirely by the employee. The plan could also include an extended list of voluntary benefits, for employees to choose from and pay for on their own.

What factors should be considered before creating a cafeteria plan?

First, benchmark the compensation and benefits norms in your industry and location. Your plan should be competitive. Second, find out what benefits employees would most enjoy. Thirdly, determine the costs of current benefits and the costs of offering the various desired options. It is also likely that savings can be found once you decide to overhaul the benefits system. It might be possible, for example, to offer wellness programs that actually reduce the cost of medical coverage.

Does a "flexible spending account" count as a benefit option?

Yes; and, sort of. A flexible spending account (FSA) allows employees to commit a portion of pre-tax wages to support anticipated medical and health care related expenses. Because they are pre-tax dollars there are direct savings involved; however, unused money put aside for these expenses is lost if the expenses do not materialize. This can be very complicated. Check with benefits administrators for details. Generally, for people with long-term chronic-care expenses, there are clear benefits and they may want to utilize this option. Other employees might prefer a different benefit; say onsite day-care.

What does the company get out of this?

Usually, improved employee satisfaction is a direct result of implementing a cafeteria-style benefits plan. This frequently results in reduced absenteeism and workforce turnover. This, in turn, leads to greater productivity and profits.

It is also possible to tie-in this benefit program directly to compensation. Some may choose higher salary and fewer benefits. It is estimated that benefits cost at least 20% of a person's salary; so some would choose a higher salary in lieu of benefits. Group benefits, however, frequently reduce the cost on a per capita basis and may actually be less costly than giving everyone a raise. For most cafeteria plans, both the employer and the employee are able to realize substantial savings.

What to DoBe Creative and Inclusive

Part of the reason old-fashioned benefits programs are taken for granted, and are largely unappreciated, is because they are perceived as a conventional solution of convenience to employers. Accept the fact that your employees are diverse with varied personal preferences and circumstances. Think about a benefits plan that offers employees a choice that meets their specific needs. Undoubtedly they will be eager to participate.

If you are creating this plan for the first time, invite employees into the decision-making process; that translates into enthusiastic buy-in when the new plan is implemented.

In designing the benefits package, first respond to your employees' wants. Then, be creative. You might want to include:

  • care givers support
  • term or whole life insurance
  • car insurance
  • pet insurance
  • child adoption assistance
  • tuition reimbursement
  • on-site massage, fitness club, convenience store
  • concierge services—allowing vendors on-site to offer services such as dry cleaning, dental and vision care, auto washing and event planning.

While some of these services and flexible work schedules are not really part of a formal cafeteria program, many employers look at them as part of an overall quality of life program that benefits everyone. In some instances, adding flexible work options to your existing benefits program may be considered one of the most valuable benefits of all.

Understand the Tax Implications

The Internal Revenue Act of 1978, Section 125, establishes a wide range of flexibility on benefit programs for employers. One major complication is that some or all of the benefits under a cafeteria plan may be "voluntary," and paid for by the employee from a "flexible spending account." Some benefits are "qualified" and others are not. Qualified benefits (and there are many) can be bought with pre-tax dollars. Doing this reduces the taxable income for the individual and the organization. Benefits that do not qualify under Section 125 are taxable.

Employers who want to qualify their programs under Section 125 must have their plans reviewed and must not discriminate based on job classification or salary range. Form 5500, which lays out the details of the program, must be filed with the Department of Labor (DOL). The DOL then determines which benefits qualify under Section 125.

To the employee, these benefits appear as a seamless offering. To the employer, however, the qualified and non-qualified parts of the program are separate entities. Thus, reporting and record keeping are more complex. For smaller companies considering broad, flexible cafeteria programs, it is advisable to hire an experienced benefits administrator—both in terms of managing on-going delivery and also for complying with tax consequences.

Communicate With Employees

As always, introducing change could create as many problems as solutions—especially if employees are already in the dark about their benefits. If employees know you're looking into an improved benefits program and are involved, either directly or through representatives, anxiety is reduced. But until the new plan is unveiled they will suspect the worst. Until the final plan demonstrates that it reflects the values and needs of employees, give frequent progress reports and updates.

If you can't manage the transition yourself, there are many well-respected benefits administrators who can help you design and implement a program that will meet your needs.

As you decide on the new plan, it might help to let employees know the actual cost of the benefits borne by the organization on their behalf as well as any new costs they must bear.

What to AvoidYou Underestimate the Value of Updating Your Benefits Package

Even if you have a good standard benefits package, the world is changing very rapidly; your employees will soon view that package as rather dull. If you want to attract and retain the best talent, you need to at least review your benefits package and consider creating a cafeteria—style plan.

Look at your bottom line, profit margins, and the outlook for the coming year. If you are not currently in a position for a complete overhaul, create a standing committee to explore options that can be introduced slowly as resources allow. Your employees will notice the effort and appreciate it, even if you can't get there in one step. Also, remember to think creatively; you may be able to inspire your employees and earn their respect for addressing their personal needs.

You Don't Provide Sufficient Support

It is better to phase in a cafeteria program than to cut back or renege on promises. Once the management team moves ahead, make sure there are enough resources for the necessary research, development, and support for whatever cafeteria program you create.

Where to Learn MoreBooks:

Rosenbloom, Jerry S. The Handbook of Employee Benefits. 6th ed. New York: McGraw Hill Professional, 2005.

WorldatWork, The WorldatWork Handbook of Compensation, Benefits & Total Rewards: A Comprehensive Guide for HR Professionals. Wiley, 2007.

Web Sites:

International Foundation of Employee Benefit Plans: www.ifebp.org

Society of Human Resource Professionals: www.shrm.org

WorldatWork: www.worldatwork.org