Section 223 vs. 125 plans

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These plans are similar but operate in different ways. Both offer tax incentives that may save your family money every year.

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Every dollar counts when it comes to balancing the family budget. As the cost of living goes up, it’s important to scrutinize where your hard-earned dollars are going. As diligent as you are, it’s possible you are overlooking a couple of benefits built into the tax code — section 223 and section 125 plans.  

These plans are similar but operate in different ways. Both offer tax incentives that may save your family money every year. We will take a closer look at each one and the impact they may have on your family’s wallet.

What is a section 223 plan?

When someone mentions a “section 223 plan” they are talking about section 223 of the tax code. This section deals with health savings accounts, or HSAs, and their tax benefits.

How to qualify for a section 223 plan

Certain high-deductible health plans make you eligible to contribute money to an HSA. A high-deductible alone isn’t enough to qualify. You can’t receive any other health insurance benefits until you meet your deductible. If you have co-pays and get discounts, your plan isn’t HSA-eligible. The only exception is preventative care — like your annual physical or flu shots.

The perks of a section 223 plan

The reason why the IRS is such a stickler about your health insurance is because HSAs offer several different tax benefits:

  • You can deduct your contributions — up to an annual limit — even if you don't itemize deductions on your taxes.
  • If your employer puts part of your paycheck into an HSA, you can subtract that money from your total income.
  • The money in your HSA rolls over every year, even if you change jobs. There’s no deadline to use the money.
  • If you decide to invest your HSA money, your earnings are tax-free.
  • If you use the money for qualified medical expenses, you don’t have to pay extra taxes when you withdraw it.

There are a lot of perks to your HSA, but you will only reap these benefits if you follow the IRS’ rules. This means keeping track of your health insurance details, contribution limits, and withdrawals. If it feels like too much, don’t be afraid to work with a tax professional.

What is a section 125 plan?

Section 125 plans are also named after — you guessed it — their section of the tax code. But more often, folks refer to them as cafeteria plans. Your company may have a written cafeteria plan and it allows you to receive certain benefits before taxes.

The basic rules of section 125 plans

Like other types of tax-friendly plans, cafeteria plans have several rules. You must have the option of picking at least one taxable benefit, like cash, and one benefit the IRS deems qualified. Qualified benefits aren’t paid for by diverting your salary and aren’t taxed as part of your income. Some examples of these include:

  • Accident and health benefits
  • Adoption assistance
  • Dependent care assistance
  • Group-term life insurance
  • Health savings accounts (HSAs)

What is a flexible spending arrangement (FSA)?

Flexible spending arrangements (FSAs) are one way to receive your cafeteria plan benefits. Your employer can use an FSA to reduce your salary to pay for certain benefits. Some of these include dependent care, adoption, or medical care reimbursement.

One of the perks is you can save on paying taxes on the money you set aside. The downside is, you have limited time to spend the money or it goes back into your employer’s pocket. Because of the “use it or lose it” rule, you need to stay organized to be successful with your FSA.

Save on taxes with section 223 and 125 plans

It’s safe to say paying less in taxes is a good thing, but staying on the government’s good side does need some extra attention. If following all the rules and tax law changes feels overwhelming, tapping a professional is always a good idea. It’s not worth losing sleep over and knowing you are straight with the IRS is priceless.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.