A Section 125 cafeteria plan is an employer benefit plan that lets you pay for certain benefits, like health insurance premiums, with money taken from your paycheck before taxes. Because that money skips federal income tax, Social Security and Medicare, you keep more of your pay than if you bought the same benefits after tax.
The name comes from Section 125 of the Internal Revenue Code. "Cafeteria" refers to the idea that you choose from a menu of benefits. Here's what a Section 125 plan covers, the rules that come with it, and what it's worth on a real 2026 paycheck.
How a Section 125 plan works
Normally, all your wages are taxable, even the part you spend on insurance. A Section 125 plan gives you a choice between taking cash wages or using part of your pay for qualified benefits. The part you put toward qualified benefits isn't treated as taxable wages.
On your pay stub, this shows up as deductions that are subtracted before taxes are calculated. Your W-2 then shows lower wages in Box 1 (income tax) and in Boxes 3 and 5 (Social Security and Medicare) than your total gross pay.
Employers must have a written plan document to offer these benefits pre-tax. If your employer doesn't have one, premiums you pay through payroll come out after tax.
What a section 125 plan can cover
| Benefit | Can be offered through Section 125? |
|---|---|
| Medical, dental and vision insurance premiums | Yes |
| Health flexible spending account (FSA) | Yes |
| Dependent care FSA | Yes |
| Health savings account (HSA) contributions | Yes |
| Group-term life insurance | Yes, within IRS limits |
| Some disability and accident coverage | Often, depending on plan design |
| 401(k) deferrals | No, these fall under separate retirement plan rules |
| Commuter and parking benefits | No, these use a different tax provision |
The simplest version is a premium-only plan (POP), which just lets employees pay their share of health premiums pre-tax. Larger employers often add FSAs and an HSA option. Read more in our guides to FSA vs HSA, the dependent care FSA and commuter benefits.
Worked example: what a section 125 plan saves in Virginia
A married couple filing jointly in Virginia earns $90,000 and is paid monthly ($7,500 per paycheck). Their family health premium is $420 a month. We compared paying the premium through a Section 125 plan with paying the same $420 after tax, using the PaycheckHubs paycheck calculator. These are 2026 estimates.
| Per monthly paycheck | $420 after tax | $420 through Section 125 |
|---|---|---|
| Federal income tax | $536.67 | $486.27 |
| Social Security | $465.00 | $438.96 |
| Medicare | $108.75 | $102.66 |
| Virginia income tax | $317.03 | $292.88 |
| Take-home pay | $5,652.55 | $5,759.23 |
Running the premium through the plan leaves the couple with $106.68 more each month, for the same insurance. Over a year, their estimated taxes drop by about $1,280. In effect, the $420 premium costs them $313.32 a month in take-home pay instead of $420.
Virginia's top rate of 5.75% starts at just $17,000 of taxable income, so nearly all of this couple's premium comes out of income taxed at that rate. The Virginia paycheck calculator lets you try your own premium. In a state with no wage tax, like Tennessee, the savings would come from federal taxes only.
Why employers offer it
Employers pay their own 6.2% Social Security and 1.45% Medicare on employee wages. When wages go to Section 125 benefits instead, the employer's share of FICA goes down too. In the Virginia example, the employer would save about $32 a month on this one employee, the same amount as the employee's FICA savings.
That's why even small employers often set up a premium-only plan: it lowers payroll taxes on both sides at little administrative cost.
The rules that come with it
Elections are locked for the plan year
You generally choose your Section 125 benefits during open enrollment, and your choices apply for the whole plan year. You can only change them mid-year if you have a qualifying life event, such as marriage, divorce, the birth or adoption of a child, a change in employment, or gaining or losing other coverage. The change has to be consistent with the event.
HSA contributions are an exception: you can usually change them during the year.
Use-it-or-lose-it for FSAs
Money left in a health FSA at the end of the plan year is generally forfeited, unless your plan offers a short grace period or a limited carryover. Elect only what you expect to use.
Effect on Social Security benefits
Because Section 125 deductions aren't counted as Social Security wages, they slightly lower the earnings used to calculate your future benefit. For most workers the effect is small compared with the tax savings.
State treatment
Most states follow the federal treatment of cafeteria plan benefits, but not all states treat every benefit the same way. If your W-2's state wages are higher than your federal wages, check with your state tax agency.
How to tell if you have one
Look at your pay stub. If your health premium is subtracted before the tax lines, or your stub labels it as "pre-tax" or "Sec 125," you're in a cafeteria plan. You can also compare Box 1 of your W-2 to your total gross pay. Our guide on how to read your pay stub explains where to find these details.
Frequently Asked Questions
Is a Section 125 plan the same as an FSA?
No. A Section 125 plan is the overall arrangement that allows pre-tax benefits. A health FSA is one benefit that can be offered under it.
Do Section 125 deductions reduce Social Security tax?
Yes. Qualified benefits paid through a Section 125 plan are excluded from wages for Social Security and Medicare as well as federal income tax.
Can I drop my health insurance mid-year under a Section 125 plan?
Only if you have a qualifying life event that allows the change, such as gaining coverage through a spouse's employer. Otherwise, your election stays in place until the next open enrollment.
Are 401(k) contributions part of a Section 125 plan?
No. Traditional 401(k) contributions are pre-tax under separate retirement plan rules, and they're still subject to Social Security and Medicare.
Sources
- IRS Publication 15, Employer's Tax Guide
- IRS Topic 751, Social Security and Medicare Withholding Rates
- IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans
Run the numbers for your state
Written and checked against IRS, Social Security Administration and state tax agency publications for the 2026 tax year. General information, not tax, legal or financial advice. Read our editorial policy, calculation methodology and sources.