The employer pays in first, using one of two formulas.
The contribution rule is what the employer gives up in exchange for skipping the annual tests. The statute offers two formulas, and the choice is mostly about cost.
Where This Rule Sits.
General information, not legal or tax advice. Statutes and IRS guidance change, so read the current text and check the details with your own counsel or tax advisor.
Simple Cafeteria Plans Overview
The full map of the safe harbor and the five rules behind it.
Permitted Benefits And Plan Document
What the contribution may be used to buy.
2027 Employer Benefit Limits
Current federal dollar limits that sit beside plan design.
Two Ways To Meet The Rule.
The employer makes a contribution for each qualified employee, meaning an eligible employee who is neither highly compensated nor a key employee. The contribution goes toward qualified benefits. The statute frames the duty as running to each qualified employee whether or not that person defers pay, and the formula you choose sets the amount.
Formula one is a flat floor: a uniform percentage of each qualified employee’s compensation for the plan year, at least 2 percent. On a $50,000 salary that is $1,000, paid on the same percentage to every qualified employee.
Formula two is a match: an amount at least equal to the lesser of 6 percent of compensation or twice the employee’s salary reduction contribution. On the same $50,000 salary the ceiling is $3,000. An employee who defers $600 draws $1,200, and one who defers $1,500 or more draws $3,000.
Under formula two, the matching rate for a highly compensated or key employee cannot exceed the rate for other employees. An employer may also contribute more than either minimum.
Choosing Between Them.
The flat formula is predictable: payroll for qualified employees times the percentage. The match formula depends on how many employees defer and by how much, so the prudent budget assumes the ceiling of 6 percent of pay for every qualified employee and treats anything lower as savings.
Whichever formula you pick, state it in the plan document in plain terms so payroll can apply it without interpretation.
Mistakes To Avoid.
Paying the flat percentage only to employees who participate. Letting the match rate for highly compensated or key employees run higher than the rate for others. Treating a cash bonus as the required contribution, when the contribution must provide qualified benefits.
Laws And Sources
Cafeteria Plans, 26 U.S.C. 125 — Subsection (j) sets the simple cafeteria plan rules; subsections (f) and (i) cover qualified benefits and the health FSA cap.
IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits — The IRS summary of simple cafeteria plans for small businesses, including the cafeteria plan written-plan description.
Highly Compensated Employee, 26 U.S.C. 414(q) — The definition the simple plan rules borrow.
Key Employee, 26 U.S.C. 416(i) — The officer and owner tests that define a key employee.
Quick Answers.
Short answers to the questions we hear most on this rule.
Does the 2 percent apply to every employee?
It applies to each qualified employee, a group that leaves out highly compensated and key employees. Those employees may still take part in the plan, but the minimum is measured on the qualified group.
Which formula costs less?
It depends on participation. The flat percentage costs a known amount of payroll. The match costs little when few employees defer and rises toward a ceiling of 6 percent of pay for each qualified employee when many do.
Can we pay more than the minimum?
Yes. The employer may make additional contributions beyond the required amount.
More Guides In This Series.
Eligible Employer Size Test
The average-headcount test, how younger companies are measured, and why related entities may be counted together.
Eligibility And Participation
Who must be allowed in, which groups an employer may leave out, and the equal-choice rule for benefit elections.
Permitted Benefits And Plan Document
Which benefits belong on the menu, which are off limits, and what the written plan should say.
Outgrowing The Size Limit
How the 200-employee growth rule lets a plan continue, and what replaces the safe harbor afterward.
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