States' Use of "Cafeteria Plans" to Provide Health Insurance

Updated: April 2014

 Richard Cauchi, Program Director, NCSL Health Program. 

About 3.7 million employers in the United States offer private or commercial health insurance to about 87 percent of the private-sector workforce - the single largest category of health coverage.[1] Yet at the same time, a pre-Affordable Care Act, 2008 report detailed that 43.7 percent of private sector establishments do not offer health insurance. The dramatic difference in these numbers mostly reflected the struggle of small and modest-sized employers to offer health coverage.[2]

Between 2006 and 2011 several states experimented with a new use for an old idea, aimed at lowering costs for both employees and their employers. "Section 125 cafeteria plans" were created by a 1978 federal law which amended the Internal Revenue Code.  Designed as an optional feature for employers, cafeteria plans allow employees to pay for a variety of health care expenses without paying any federal tax on those charges. The result can be a savings of between 25 percent and 40 percent of every dollar the employee contributes to his or her plan.  The employer also realizes savings on FICA withholding tax for each participating employee, typically around $160 per year.  It costs about $100 per year per employee to create and administer a health-only cafeteria plan and several national companies compete for this business.

HOW IT WORKS (Sample Employee Notice)
A "Cafeteria Plan" is a benefit provided by your employer which allows you to contribute a certain amount of your gross income to a designated account before taxes are calculated. These accounts are for insurance premiums, and medical (or dependent care) expenses not covered by your insurance, from which you can be reimbursed throughout the plan year or claim period as you incur the expenses. A cafeteria plan allows you to reduce your gross income, thereby reducing the amount you pay in Federal, Social Security, and some State taxes - a savings of between 25 percent and 40 percent of every dollar you contribute to the plan.

Cafeteria Plan State Laws

Legislation 2007 to 2011

Federal laws & Health Reform

Many employers sponsor and offer such cafeteria plans as an additional benefit to workers, often combined with a direct employer contribution to a group health insurance plan, although not all are structured to allow premium payments.  The Segal Company concludes that while "most employers with health insurance already provide premium-only cafeteria plans for eligible employees," up to 10 percent of employers do not.  Again, in most cases it is smaller employers who do not provide these plans.   

State and Legislative Roles

At least 13 states adopted a cafeteria plan approach into state-based health reforms, with a dual goal of keeping coverage available and affordable while expanding the numbers using commercial health insurance.

In five states (CT, MA, MN, MO, RI), use of recently-enacted cafeteria plan laws are mandatory for some employers; this creates a kind of portability for enrollees, since changing employers may allow the worker to keep the same insurance policy.

2009-2010 Activity:  For 2009-10  sessions, bills to expand use of section 125 cafeteria plans were discussed in at least eight states, including Alaska, California, Iowa (enacted), Kansas, Mississippi, New Jersey, Oklahoma and Washington (as of 12/09). 


The federal law authorizing Cafeteria plans is cited as 26 U.S. Code §125 [text online].  The Internal Revenue Service (IRS), Treasury promulgated Final Regulations in 2000, affecting Section 125 Plans, which are online as 26 C.F.R. Part 1 [TD 8878]; this IRS version includes a practical summary, a chronology and contacts at IRS.  

ERISA: compatible or conflicting?

For states concerned about federal preemption of state law, cafeteria plans may be one of the safer approaches. The federal law requirements are well known and have even become slightly more flexible.  One ERISA expert, Patricia Butler authored a report published July 2008 describing it as follows: "Because Section 125 plans are "group health plans" under the Internal Revenue Code, it appears they are subject to both employer notice provisions under COBRA and employers and insurer nondiscrimination and benefit design requirements under HIPAA.  But because the definition of employer group health coverage is different under ERISA than under federal tax code, as long as employers do not endorse or promote specific individually purchased health insurance policies, these policies should not be subject to ERISA.  Nor should a state requirement that employers offer Section 125 plans be preempted by ERISA.  However, states still cannot regulate "self-insured" health plans sponsored by many large employers.  Drafters need to recognize that care is needed to avoid a challenge to any broader law. 

Cafeteria Plans Under Federal Health Reform

The Affordable Care Act (ACA) modified the ways that Cafeteria Plans fit with employer-based health insurance.  It led to an annual limit of each individual's account to $2,500, although a family with two or more employed members may each have an account. 

  • 2014 Update: Guidance issued by the US Dept. of Labor and the IRS stated that, starting in 2014, employers can no longer offer Section 125 plans to employees to purchase non-group health insurance without an employer contribution.

As of 2014, there are two ways that money can be extended beyond the calendar year.  The following consumer advice was pubished as "It’s Autumn, Time to Check Flexible Spending Accounts" [10/29/2013, (c) the New York Times, at ] .  Highlights include:

  1. About 23 percent of people with private health insurance were in a family that had an F.S.A. for medical expenses, as of January 2013, according to the Centers for Disease Control and Prevention. That is an increase from about 19 percent in 2008.
  2. If you have a medical expense, the funds in a flexible spending account are available to you once the plan year starts; you don’t have to wait until you have accumulated enough to cover a bill.
  3. The catch has been that if you don’t use all the money by the plan’s annual deadline, you forfeit it. On (Oct. 29, 2013), the Treasury Department said employers could now allow plan participants to carry over up to $500 of health F.S.A. balances remaining at the end of a plan year. The rollover could begin as early as this year, although employers are not required to go along.
  4. Many flexible spending accounts have traditionally had calendar-year deadlines, requiring that the money be spent by Dec. 31. Tax rules have let companies offer an extra two-and-a-half-month grace period after Jan. 1, if they choose, giving employees until March 15 to spend the money. But given the new guidelines, you should check with your human resources office to see whether your company will allow a rollover or will continue to require you to spend the money but with a grace period. The new rules permit either a rollover or a grace period, but not both.
  5. F.S.A.’s cannot be used for over-the-counter drugs unless you have a prescription. It may seem odd to ask your doctor for one, but it’s worth it for a product you expect to take routinely — say, cough medicine for colds, or glucosamine for joint health.  Many over-the-counter items, however, don’t require a prescription for reimbursement, including products like sun block and contact lens cleaning solution.
  6. list of items eligible for reimbursement from a flexible spending account:  In general, items that are deductible as medical expenses on your taxes are eligible for F.S.A. reimbursement. You can check Publication 502 from the Internal Revenue Service.
  7. How much can I set aside in my F.S.A.? The Affordable Care Act set a limit of $2,500 for deferrals in flexible spending accounts. (The limit is indexed to inflation; the government hasn’t yet said what the limit will be for 2014.) That limit is per person; you and your spouse can each set aside $2,500.

  8. Can I use both an F.S.A. and a health savings account? Yes — but if you have a health savings account, the flexible spending account must be a “limited purpose” version that allows reimbursement only for dental and vision expenses, said Roy Ramthun, an H.S.A. consultant.

Cafeteria Plan State Laws

There are considerable differences among the laws and plans.  Individual state laws are detailed in the table below.



Required & Optional Features


On July 10, 2007 Connecticut enacted legislation (SB 1484) mandating cafeteria plans. The Connecticut law requires any employer providing health insurance benefits paid partly through payroll deductions to offer a cafeteria plan, effective October 1, 2007. To simplify employer paperwork, there are no filing requirements under this mandate.

"Any employer that provides health insurance benefits to its employees for which any portion of the premiums are deducted from the employees' pay shall offer such employees the opportunity to have such portion excluded from their gross income for state or federal income tax purposes, except as required under Section 125 of the Internal Revenue Code of 1986..."  
(Public Act 185, July 2007, now Conn. Gen. Stat. Section 38a-1041(f) ).

Required for some employers w/ health insurance


Creates the Cover Florida Health Care Access Program, which requires that employers who (voluntarily) choose to participate in the Access Program enroll by complying with the procedures which must include, "compliance with federal tax requirements for the establishment of a cafeteria plan, pursuant to section 125, including designation of the employer's plan as a premium payment plan, FSA [Flexible Savings Account] or both."  Also revises the eligibility requirements for participation in the Medikids program or the Fla. Healthy Kids program.
(S. 2534 signed into law 5/21/2008, now Fla. Stat §408.910(4)(c) ).

Optional for employers


Creates a tax credit to encourage employers to establish a fully insured health plan in combination with a 125 plan.  The state will provide the lesser of $50 per employee or $2,500 for 2 years if the employer offers such a plan. Applies to all Indiana firms that do not have a Section 125 plan. (Effective 01/2008, Mathematica Fact Sheet 7/18/08)

Optional for employers


Requires the Commissioner of Insurance to  "assist employers with twenty-five or fewer employees with (voluntarily) implementing and administering" Section 125 plans including medical expense reimbursement accounts; also requires cafeteria plan features on the division's internet site. (HF 2539, signed into law May 13, 2008, now Iowa Code §505.31)

Requires that the Iowa Choice Insurance Exchange Act "shall study the ramifications of requiring each employer with more than ten employees in the state to adopt and maintain a cafeteria plan that satisfies section 125." Amended to Create a Health Care Coverage Commission.  (S 389, signed into law by governor as Chapter 118, 5/19/2009)

Optional for employers


Requires all insurers to offer premium-only Cafeteria Plans, while language stating that employers "shall" offer plans was amended to "may offer."  (SB 81, signed into law as Chapter No. 2008-164, 6/9/2008)

Establishes the Small Employer Cafeteria Plan Development Program Fund  for FY2008, and appropriated $150,000. (SB 357, signed into law as Chapter No. 2007-201, 7/13/07)

Optional for employers
Required for insurers


Creates the Working Families and Small Business Health Coverage Act. This is a voluntary plan with a specialized scope - offering subsidies to the smallest businesses, with one to nine employees. Those that join must offer a cafeteria plan.  Employers are under no obligation to apply for or participate in the small business subsidies and any employer with ten or more employees is ineligible. (SB 6, signed November 2007, effective Sept. 2008)

Optional for employers w/ 1-9 employees.


Massachusetts in 2006 became the first state to require that all employers with 11 or more workers offer at least a "premium only" cafeteria plan. That requirement took effect on July 1, 2007 and is "one of the primary employer responsibilities" within a larger near-universal health plan, also requiring at least $295 annually in employer payments toward health costs and an individual mandate for residents to enroll in an insurance plan.  The law also includes state subsidized coverage and Medicaid expansions. [3]  (Chapter 58 of the Acts of 2006, section 48; Mass. Gen. Laws Ch. 151F, §2)

LAW REPEALED - Massachusetts Section 125 Cafeteria Plans (956 CMR 4.00)

  • Statutory repeal background:
  • Guidance issued by the US Dept. of Labor and the IRS stated that, starting in 2014, employers can no longer offer Section 125 plans to employees to purchase non-group health insurance without an employer contribution
  • This language appeared incompatible with the provisions of Mass. 956 CMR 4.00, which requires employers to offer Section 125 plans under which an employee can purchase health insurance without any employer contribution. As such, the statute (Ch. 151F) was repealed in an FY2014 Supplemental Budget, (Ch. 52 of the Acts of 2014)

Article:  "How Have Employers Responded To Health Reform In Massachusetts? Employees' Views At The End Of One Year."  Health Affairs, online 10/28/08. [8 pages Adobe PDF PDF]

Required for employers w/ 11+ employees; also employer $ contribution


Requires all employers with 11 or more employees who do not offer health insurance to establish a Section 125 plan.  It does not require employers to offer insurance coverage or contribute to it.  Includes an "opt out" provision.   The Commissioner of Employment and Economic Development will make available grants of up to $350 to certain small employers that establish Section 125 Plans to offset the cost of establishing the plans.  (SF 3780, signed into law 5/29/08 as Chapter 358, section 10; Cite as: Minn. Stat. §62U.07)  | MN Agency link

Required for employers w/ 11+ employees


Enacted legislation mandating cafeteria plans. The law applies to all employers with insured plans, effective Jan. 1, 2008. Self-insured plans are exempted. In both Connecticut and Missouri it is a pre-requisite that the employer have a health plan in place prior to being required to set up cafeteria plans.[4]  Both the Missouri and Connecticut laws require that employers establish cafeteria plans only if employees pay any part of premiums. Thus, if the employer pays the full cost of the insurance, the employer is not required to set up a cafeteria plan.  (HB 818, June 2007)

Required for employers  w/ insured plans

Rhode Island

RI became the first state to base a health insurance reform plan primarily on required use of Section 125 cafeteria plans (for employers with 25 or more workers). Unlike Massachusetts, the RI law makes clear that employers do not have to "pay for or otherwise contribute to, the cost of any health insurance purchased through the cafeteria plan."   The law took effect "upon passage," but is set for implementation July 1, 2009. (S 448, signed into law 7/2009, now R.I. Gen. Laws §27-70-1 through 3)

Required for employers w/ 25+ employees


These laws require that "any employer who has implemented a cafeteria plan (pursuant to this section) shall arrange for its employees' health insurance premiums and dental insurance premiums to be automatically paid through the cafeteria plan beginning January 1, 2008."  (S 333; signed into law as Chapter 184, 5/18/2007 & H 3360; signed into law as Chapter 674 4/1/2008)

Optional for employers


Establishes the Utah Health Insurance Exchange, allowing  small employers with up to 50 workers buy a choice of policies.  An employer that chooses to establish a defined contribution arrangement to provide a health benefit plan for its employees is required to provide for a pre-tax contribution including a Section 125 cafeteria plan.  (S 188, 2009 Law) 

Optional for employers


Enacts a voluntary Health Insurance Partnership for small business employers in which all participating employers are required to offer "125 plans." The state-run partnership in turn is required to "provide Cafeteria Plan technical assistance" to small employers, defined as those with one to 50 employees.  Larger firms are not affected. (SB 5930, 2007 law)

NOTE: Parts of SB 5930 have been delayed by passage of a 2009 law, H 2082.

Optional for employers

Other uses and references to Cafeteria Plans


Maine's comprehensive health reform, Dirigo Health, included the following authorization for the state program, although it did not require employers to use Section 125 accounts:  "Dirigo Health may administer or contract to administer Section 125 plans for employers and employees participating in Dirigo Health, including medical expense reimbursement accounts and dependent care reimbursement accounts."
(2005 law, Chapter 400, Pt. C, §8 (AMD).)

Optional for agency
and employers

Beyond these 13 states, at least 10 others considered Cafeteria Plans as stand-alone bills or as a part of broader reform. Three widely publicized California reforms requiring Cafeteria Plans passed both chambers but did not become law.  (See separate bill list below)


EXAMPLE OF STATE-AUTHORIZED "Section 125 Plan" SAVINGS: (calculated by Massachusetts, 2007)

An employee who pays his/her health care coverage premiums on a pre-tax basis realizes a savings on state income, federal income and federal FICA taxes. This tax savings could amount to as much as 40 percent of the cost of health care coverage. The employer also realizes FICA withholding tax savings for each participating employee.

The example below illustrates the annual tax savings realized by an employee in Massachusetts with adjusted gross income of $50,000 who participates in his/her employer’s plan.  In this example, the employee achieves annual tax savings of $796 and his/her employer saves $161 in annual FICA taxes.


Financial feature

w/o Plan

with Plan

Adjusted Gross Income



Annual Pre-tax Health Care Coverage Contribution


$ 2,100

Taxable Income



Estimated Taxes



Annual After-Tax Health Care Coverage Contribution

$ 2,100


Net Take Home Pay

$ 35,224



2007 - 2010 Section 125 Cafeteria Plans - Legislation Examples Not Enacted

The following measures are excerpted from a 50-state search. Lists may not be exhaustive.  Enacted laws are listed in the main report and generally are not repeated below.



 Description; Status



SB 61;  Would establish an Alaska health care program to ensure insurance coverage for essential health services for residents of the state, the Alaska Health Care Board to administer the Alaska health care program and the Alaska health care fund, the Alaska health care clearinghouse to administer the Alaska health care program under the direction of the Alaska Health Care Board, and eligibility standards and premium assistance for health care coverage.  An employer that establishes a cafeteria plan that offers employees the option to elect health care insurance coverage that meets or exceeds essential health care services is not subject to the payment requirements.
(Substitute bill reported favorably, 3/16/09; did not pass 2009  session)

SB 160;  Mandatory Universal Health Care plan, would require employers to participate in the Alaska health care program with payrolls of $1,000,000 or greater, the employer shall pay two percent of the gross payroll.  An employer that establishes a cafeteria plan that offers employees the option to elect health care insurance coverage that meets or exceeds essential health care services is not subject to the payment requirements. (Did not pass by end of '08 session)




SB 594;  Would authorize an employer tax credit for a portion of the administration cost paid by a qualified business taxpayer in connection with establishing or administering a qualified cafeteria plan that provides for the payment of health premiums of the taxpayer's employees.  (Filed 3/19/09; did not pass committee 5/20/09)

AB 1072, SB 820;  Comprehensive health care reform and coverage expansions.  Included requirements that employers with varied numbers of workers sponsor and offer a premium cafeteria plan; employers also were required to contribute at least $395 annually toward the cost of health insurance premiums.

AB 8  Would require every employer in the state to "adopt and retain a cafeteria plan (passed by Assembly and Senate; vetoed 10/12/07)

SB 23 a, AB 8 a , AB 2 a, AB 1 a (passed Assembly; did not pass Senate 1/18/08)

AB 2 a (Speaker Nunez) : would, beginning January 1, 2010, require an employer, as defined, of 2 or more full-time equivalent employees in the state to adopt and maintain a cafeteria plan to allow employees to pay premiums for health care coverage to the extent amounts for that coverage are excludable from the gross income of the employee, as specified. The bill would require an employer who fails to establish or maintain a cafeteria plan to pay a penalty of $100 or $500 per employee, as specified. (Did not pass Assembly 11/17/07)



Colorado (Blue Ribbon Commission for Health Care Reform) Final "5th Plan" released 1/31/08 includes "Require Colorado employers to establish at least a Section 125 premium-only plan that allows employees to purchase health insurance with pre-tax dollars.

(Recommendation 17a)   This recommendation was endorsed by the Commission’s Business Advisory Task Force.44 For employees with access to employer coverage, the ability to purchase coverage on a pre-tax basis can reduce the cost of coverage, the amount depending on the employee’s tax rate. The Lewin Group further estimates that Coloradans would save $372.9 million on their federal taxes through the use of 125 plans. Employers also could have the option to extend this pre-tax benefit to employees who are not eligible for the group plan but have established a “voluntary” individual plan with the Connector." [Final Report]



SB 28, SB 150;  The employer would agree to also sponsor a 'cafeteria plan'



SB 5;  No later than January 1, 2009, each employer with more than 10 employees shall adopt and maintain a cafeteria plan that satisfies 26 U.S.C. 125. (Held in committee 12/3/07; did not pass by end of '08 session)



(Commission on  Affordable Health Care Plans for Small Businesses and Families)
**Dec. 2007.  Would require use of 125 Cafeteria plans - not yet filed as bill. 1/31/08

SSB 3140  -- Creates the Iowa Health  Care Coverage Exchange and Board, including "Studying the ramifications of requiring each employer with more than ten employees in this state to adopt and maintain a cafeteria plan"  (Did not pass Senate 3/11/08)



H 2262;  Would establish a small employer cafeteria plan.
(Sent to Appropriations Committee; did not pass 2/18/09; may be subject to carryover to 2010)

KS S 540; Kansas small business health policy committee may provide grants to small employers for the purpose of establishing a cafeteria plan authorized IRS Section 125. (Held in committee did not pass)

KS H 2591;  In order to encourage and to expand the use of cafeteria plans authorized by 26 U.S.C. 125, by small employers, there is herby established the small employer cafeteria plan development program.  (Did not pass, 3/22/2007)



HB 3936 of 2007.  Any employer with the equivalent total of five full-time employees must offer a cafeteria plan.  (Did not pass by end of session 2008)



SB 2171, SF 3099 establishing the Minnesota Health Insurance Exchange; requiring Section 125 Plans (passed & vetoed 5/8/07)

HB 1729 (Did not pass) Effective January 1, 2009, all employers with 11 or more current employees shall establish a Section 125 Plan to allow their employees to purchase individual market health plan coverage with pretax dollars

HB 1873 (Did not pass House 5/21/07),



H 573: Mississippi Health Insurance Exchange Act of 2009

S 2086: Small Employer Insurance Association Act, would create cafeteria plan. 
(Did not pass committee 2/3/09)


New Jersey

A 2208;  Would require certain nongovernmental employers to provide health care premium conversion plans for employees.
(Filed 2/26/08; withdrawn from consideration 9/22/08)

A 3452, S 2202;  Requires all nongovernmental employers with 11 or more employees that provide their employees with health care coverage to also provide the employees with a cafeteria plan. (In comm. 2/28/08)

A 3766;  Creates the State Health Insurance Exchange Act; providing employers with information about establishing and maintaining cafeteria plans

S 1147Only for community colleges, requires establishment of cafeteria plans and collective negotiation of waiver terms prior to offering employees incentive to waive health care benefits.


New Mexico

(Governor)  If an employer with 6+ employees has been doing business in NM for at least 3 years must offer this option whether or not they contribute to coverage plan.   **Dec. 2007



Would require school districts to establish cafeteria plans.
(Filed; did not pass committee 2/3/09; subject to carryover to 2010)



H 2052 delays implementation and the operation of the Health Insurance Partnership unless sufficient state or federal funds are provided earlier. Passed House; signed into law by governor 4/28/09 as Chapter No. 257

H 5947 would establish the Washington State Apple Health Insurance Board to facilitate the availability, portability, choice, and adoption of private health insurance plans to eligible individuals and group, including use of cafeteria plans.  (Did not pass committee; may be subject to carryover to 2010)


Sources: NCSL legislative research; [password only] cafeteria plan search powered by StateNet.

"Legal Issues in State Requirements that Employers Offer Cafeteria (Section 125) Plans" by Patricia Butler, JD, Dr.PH in conjunction with the Institute for Health Policy Solutions.  Published by California HealthCare Foundation, 10/6/08 [27 pages Adobe PDFPDF]

[1] RWJ. :"How Costs are Being Squeezed" page 6.  April 2008.
[2] Kaiser/HRET Survey of Employer-Sponsored Health Benefits, 2007.
[3] The state has published a 52-page "Section 125 Plan Handbook for Employers" that provides extensive practical, financial and legal information that may be applicable to other state plans and proposals.  See online:
[4] Joanne Hustead, senior health compliance specialist with the Segal Co.


Compiled by NCSL Health Program, Denver, CO 80230

Web address:  

  • Reviewed 5/13/11- RC, SL