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Most think of flexible benefit plans as some sort of a voluntary product or get it confused with a Health FSA. Employees estimate their health care expenses not paid by insurance and set aside pre-tax dollars for those expenses through salary redirection. Both the employees and employers save significant tax dollars. But that’s not really what a flex plan is—rather it’s a tax advantaged vehicle for paying for a number of benefits.

So how can employers get more employees to participate in the plan? They might try an employer flex credit plan. This type of plan involves some employer funding through a cafeteria plan, but can result in two things; greater employee satisfaction with their benefits package and greater savings for the employer. In many cases, it simply redefines employer costs for benefits into a different vehicle.

What is a flex credit plan?

A flex credit plan starts with understanding the employer’s current financial commitment to employee benefits. Instead of charging employees a portion of the premium cost, the employer makes the employer’s contribution to the premium visible as flex dollars, then available to employees to augment their salary redirections to a flexible benefit plan. Employers can earmark flex credits for a specific benefit, like medical coverage or to help the employee defray health care expenses or deductibles. Flex credits can even be converted to cash, depending on plan design and subject to some state laws.

Under a Section 125 plan, employer credits are tax deductible to the business and a non-taxable allowance to employees. However, if employers allow and employees choose to take the credit as cash – that amount is taxable to employees. A caution here: Plan sponsors should not make this option too tempting. After all, the credits are to encourage participation in the benefit plan, and that’s where the dollars should stay.

Why implement a credit-based system?

Flex credits increase employee awareness of their benefits. When was the last time you saw someone pass up free money? There’s a sudden interest in the flexible benefit plan when an employer gives money away. Now employees are reading about the plan, and planning on how to spend the money. They also realize just how much benefits cost, particularly if the flex credits equal the employer’s cost for benefits.

When employers raise interest in the plan, employees participate in greater numbers and for larger dollar amounts. For employers it means increased tax savings when more money flows through the plan.

Employers improve control of benefit dollars. Here’s an example. If an employer makes $1,000 available to each eligible employee, selecting single coverage, the budgeted amount of employer credits every year limits liability of higher costs in the future. Generally, it moves the employers strategy from defining the benefits to defining the contribution to benefits—a more focused and total compensation approach.

Employees have different needs. A diverse workforce includes singles, families with children and older workers all of whom have different health care needs. By providing flex credits, an employer moves the “one-size-fits-all” design toward a more customized approach that makes room for life cycle choices.

Finally, surveys prove that employees who have a choice between a menu of benefits not only empowers current employees, but attracts and retains good employees.

Taxable and non-taxable flex credits

Just because an employer is making flex credits available through a cafeteria plan, does not mean it has to be non-taxable dollars flowing through the plan. A very elaborate benefits package can be delivered through the cafeteria plan, ranging from employer dollars used for health insurance premiums to taxable dollars for incentive bonuses.

For example, flexible benefit plans can deliver, with taxable employer dollars, attractive incentives or life cycle extras that provide money for the purchase of a home or a reward for employment longevity.

Plan Designs

Determining the amount of flex credits is the first place to start. Employers can use this opportunity to think about their total rewards strategy and how they want to position their benefits. Credits may vary based on employee choice of health plans, for example offering more credits to those who choose family coverage versus those choosing single coverage. Consideration should be given to how credits will be used. Employers can restrict the use of credits for medical coverage or for dental coverage, for example.

Credits may also be redeemable for cash. Employers may want to ensure a safety net of coverage for every employee, so that only those who have health insurance coverage elsewhere can turn credits into cash. However, the purpose of the plan is to efficiently deliver benefits and not to increase taxable cash flow for employers. As such, an employer may decide to reduce the value of cashable credits (for example, a credit may have a $1 value if used for benefits under the plan but just $.25 if cashed out).

A 401(k) option under the cafeteria plan is another great choice with flex credits. For instance, not all employees will use the flex credits for benefits. By placing a 401(k) contribution option within the flex plan, employer credits could flow to a 401(k) plan. The 401(k) plan document need not be amended and most everyone could use the flex credits.

What’s the down side?

Flex credits can be complicated to understand unless communicated well.

Employers may see an increase in time spent for internal administration to track credits and employee education. Too much flexibility and choice may cause employee frustration. This is where timely employee education kicks in.

Adverse selection of benefits or cash can be a cause of alarm. In fact, for that reason, many employers do not allow a cash-out option. Why create hard dollar costs in the form of taxable compensation for employees who are covered elsewhere, if it happens today without additional compensation to employees? During the plan year take time to evaluate and make a note for future year adjustments. This is a living, breathing entity and will experience adverse selection. Periodic reviews of usage is necessary to determine whether it is meeting both employer and employee needs.

Review current benefits

The first planning session with an employer is a review of current benefits, employee demographics and includes a list of employer and employee needs. Does the plan include adding benefit selections? Ensure the ground rules are laid out and all decision makers have answers to their questions.

The amount of money employers are willing to spend will depend on management philosophy and whether a company is small and emerging or an established institution with positive cash flow.

Here are a few bullet points to thrash out:

What is the employer’s philosophy towards compensation and benefits?
Does the employer currently differentiate costs by family coverage category?
How many employees are currently waiving medical coverage?
Credit type (benefit specific or for general use) and amount.
Offering fewer or more benefits.
Taxable benefits offered.
Goals. For instance, is the objective to reduce benefit dollars or increase transparency of benefits?

Start simple

An employer match plan is one of the simplest flex credit plans to install. Employees commit a certain dollar amount to the plan and employers match the figure, up to a certain dollar amount. It works much like an employer match in a 401(k) plan. Not only do employees have more choice, but participation in the flexible benefit plan will soar. Moreover, remember the more salary redirection by employees, the bigger the payroll savings for employers.

The employer could also make available a small amount of flex credits as “seed” money to a Health FSA. All eligible employees receive this “seed” money at the beginning of the flexible benefit plan year. As participants start to fill out claim forms in order to receive nontaxable payments, they realize how easy it is to participate in the plan.

When employer “seed” money is gone – they can see how their eligible expenses continue to pile up. Expenses they could have paid with untaxed dollars. The key is to keep this experience in the fore-front of employees’ minds—so they make a different choice the next plan year.

Educate employees

No use having a party if no one attends. Employee education is the second most important aspect of offering a flex credit plan; the first being the actual development and implementation of the plan. Set aside adequate time to inform and educate employees and develop a timetable to include vendor selection, education and review of selections and usage throughout the plan year.

A flexible benefit plan is a perfect choice for most employers. Employee approval ratings take off and benefit knowledge accelerates. Alternatively, when an employer takes his flex plans to the next level with employer credits, both sides gain financially.

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The information contained in this article is not intended to be legal, accounting or other professional advice. We assume no liability whatsoever in connection with its use, nor are these comments directed to specific situations.