Topic: HR & BENEFITS

As a PEO founder and former owner, I am aware of all the details and moving parts surrounding the co-employment experience. When you focus on growth, it can become easy to lose sight of some of the best paths to pursue. I recall signing up new groups and going through the milieu of employee enrollment processes. Usually at the end of all the HR intake and benefits explanation and enrollment, there’s a discussion on Section 125 and flex plans.   

Typically, the enrollees are overloaded at this point, as are the enrollment staff, so less attention is paid to the importance of this benefit to both the participant and to the PEO.  To the extent you can encourage participation in the Section 125 pre-tax employee benefits, however, you will provide the participant with an increase in take-home pay, and the PEO (as the W-2 employer) may see FICA tax savings. 

IRS code Section 125 allows employers to offer a qualified benefit plan that pays for an employee’s portion of insurance premiums, out of pocket medical expenses, and day care expenses on a pre-tax basis. This means that employees, through a payroll deduction election, can fund accounts to pay for these expenses as they come up during the plan year.  The more the participant uses these accounts to pay for items they would be paying for anyway, the more their taxable income decreases for the year.    

For instance, if an employee making $45,000 a year elects to set aside $2,500 for out-of-pocket medical expenses and contributes $1,200 yearly for their portion of insurance premiums, these funds are deducted from his or her paychecks over the year, so his or her taxable income in this example will be $41,300 for the year.  The $3,700 they elected comes tax free. In this example the PEO would pay FICA taxes on $41,300 instead of the full $45,000, so their tax saving will be approximately $267 for this individual. If there are 500 participants in the Flex Plan at this level, that’s over $133,000 per year in FICA savings! That’s the reward.   

There is also risk: the ‘availability rule’ for the health FSA.  The health FSA is governed by Section 105 of the IRS code which manages self-insurance.  The health FSA is therefore governed by ERISA, and the IRS has instituted regulations that make this account look and act like insurance.  The risk component is that the participant, who can elect up to $3,050 in 2023 for the health FSA, is entitled to access and use the entire amount at any time during the plan year. 
Since the account is funded through payroll deduction, the account isn’t fully funded until the end of the year.  If the employee terms in the middle of the plan year, the account is underfunded. Under IRS regulation the employer cannot recoup the shortfall. This can be a concern for some PEOs that don’t want to take the risk; some will shift the health FSA risk onto the worksite employers. These PEOs generally have very low participation, and they are missing out on the FICA savings reward.   

There is also perceived risk to the participant. Consistent with insurance principles, the participant is at risk in losing his or her annual account election if they don’t use the funds. This risk has been mollified with the introduction of the $500 annual rollover option, which has greatly reduced the perceived risk and has fostered greater plan participation across the board.   PEOs that incorporate the annual rollover into their plan designs and that effectively communicate this feature have enjoyed higher participation levels and greater overall FICA savings.   

Fortunately, most PEOs have learned and recognize that the reward is far greater than the risk.  In my 29 years of experience in the PEO industry, first as an owner then affiliated with three TPAs handling FSAs for PEOs, the reward has always been markedly greater than the risk.  Contrary to the fears of some, not everyone gets laser surgery in January then quits. Rather, over the plan year, the PEO can expect to save on average $230 per participant per year in FICA. The more participants you have, the more the risk diminishes and your FICA savings increases.   

To build a successful Section 125/flex benefit program, you should consider a few key points.  

Compliance. Stay on top of plan structure and strategy, plan documents, claims review and non-discrimination testing.  While there is no direct recognition of co-employment in Section 125 of the IRS code, thoughtful application of compliance elements will easily put the PEO in good faith compliance with the regulations.
 

Simplify. Make it easy to explain and easy to use. Effective staff training will bolster awareness of the benefit, and will allow for a consistent manner in communicating the benefits of participation.  

Updated Technology. Things like smart phone apps for account access and management and debit card convenience and file integration to off-load internal staff functions can greatly enhance participation levels.  

Risk Management. Manage any clients that are insisting on keeping the FICA savings by having them assume the above-mentioned risk components in their CSAs.  They are hiring the PEO to manage employment risk, and there are effective methods to encourage them to participate in your program.  

Lean on Experts. Work with trusted advisors who can lead you through the regulatory morass and who have a track record of working effectively with PEOs.  There is no substitute for experience, and choosing the right partner will greatly enhance your flex benefit program. 

Section 125 Plan Flexible Spending Arrangements are a great supplementary benefit PEOs can offer to their worksite employees.  If set up and administered correctly, both the participant and the employer/plan sponsor can enjoy significant tax savings.  While the co-employment environment can offer unique challenges, proper handling by experienced advisors can ensure a successful experience.  So, get your plan tuned up and ready so you can expand your participant base and create a satisfactory participant experience in these benefits.

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