What Expenses Are Allowed in a Section 125 Cafeteria Plan?

To participate in a cafeteria plan, you contribute a set portion of your pretax income each pay period to an account held by your company’s benefits administrator. At the end of the year, the contributions are subtracted from your gross income, reducing your taxable income. Throughout the year, you can use the money you’ve contributed to pay expenses associated with the programs your employer offers, either through a reimbursement process or by using a debit card.

A cafeteria plan allows an array of health-related expenses. You can guess the obvious things: visits to the doctor, prescriptions, lab work, X-rays, medical equipment, and vision and dental care. As of Jan. 1, 2011, over-the-counter drugs are excluded unless a doctor writes you a prescription. The plan also allows premiums for health, vision, dental and some long-term care insurance as well as group term life insurance. If your insurance is through your employer and it qualifies, your premiums will come out of your paycheck before your taxes.

Expenses that are indirectly related to health care may also be allowed. For example, if you have to travel to receive medical treatment, you can be reimbursed for some travel costs and for lodging. Bottom line: If a doctor is telling you to do or get it, check to see if it’s on the list.

You can contribute to health savings and flexible spending accounts through a cafeteria plan. When you enroll, you will designate a regular contribution from your pretax income. It’s important to understand the most important differences between the FSA and HSA before you enroll.

An FSA is owned by your employer, who determines eligibility. Beginning in 2013, the maximum annual contribution is set to be $2,500. The advantage of an FSA is that you can use up to your total annual contribution any time, no matter what you’ve contributed. For example, if you put in $50 a month and in month two you have a $200 medical bill, you can pay it with plan funds despite a balance of only $100. But budget carefully: An FSA is a use-it-or-lose-it account. If you don’t use all the funds during the plan year, you forfeit the money.

An HSA is owned by you. In 2012, you could open an HSA if your individual health insurance deductible was at least $1,200 or at least $2,400 for family coverage. In 2012, individuals could contribute up to $3,100 and families up to $6,250. The key benefit of an HSA is that you never lose your money. If you don’t use it within the plan year, it simply stays in the account. The disadvantage is that you can use only contributions you’ve already made. So in the previous example, because you've contributed only $100, you can't cover the whole $200 bill.

If you’re working or looking for work, cafeteria plans allow the costs of care for a child or other qualifying dependent. Kids under 13 and older children or adults who live with you more than half the year and are physically or mentally unable to care for themselves usually qualify. For children, nursery or preschool programs are eligible expenses, and after-school or day care programs are allowed for your older kids. If your spouse or parent must attend a dependent care center, you can be reimbursed for those costs if the facility meets state and federal regulations.

Instead of claiming an adoption tax credit, a cafeteria plan lets you budget those expenses and be reimbursed for them along the way. Costs related to the legal adoption of a child -- in some cases, even costs associated with an unsuccessful attempt at adoption -- are allowed. Use cafeteria funds to pay legal expenses, including attorney fees and court costs. If you have to travel to visit or pick up your child, many of those expenses are allowed too.

The decrease in your taxable income under a cafeteria plan could adversely affect your Social Security benefits because your benefit is based on your income level while you were working. Consult your tax professional about your individual situation or to get answers to questions about other allowable expenses.