Section 125, HSA and FSA guide

Not tax or legal advice; consult a benefits or tax professional. This page is general information for a mid-market employer. Each statement is attributed to an IRS or federal source we read on 14 October 2026, and dollar limits change every year.

What this page adds

Related pages cover how health coverage is funded in level-funded health plans, the employer shared-responsibility test in the ACA employer mandate guide, plan documents and annual reporting in the ERISA and Form 5500 guide, continuation coverage in the COBRA employer guide and cost comparison in benefits benchmarking. This page covers only the pre-tax plumbing: the cafeteria plan, HSAs and health FSAs.

What a Section 125 cafeteria plan is

26 U.S.C. 125(d)(1) (retrieved 14 Oct 2026) defines a cafeteria plan as “a written plan” under which all participants are employees and the participants may choose among two or more benefits consisting of cash and qualified benefits. IRS Publication 15-B (retrieved 14 Oct 2026) describes it as a written plan that lets employees choose between cash or taxable benefits and certain qualified benefits, and states that choosing a qualified benefit does not make it taxable merely because cash was available. Together, those two sources are why a plan document matters: the statute makes a written plan part of the definition. We did not read the regulation sections that set out what the written plan must contain (see “What we could not confirm”).

Publication 15-B lists the qualified benefits a cafeteria plan can include: accident and health benefits (but not Archer MSAs or long-term care insurance), adoption assistance, dependent care assistance, group-term life insurance, and HSAs. It lists benefits a cafeteria plan cannot include, among them de minimis benefits, educational assistance, employee discounts, meals and transportation (commuting) benefits. It also states that a cafeteria plan generally does not include a plan that defers pay, though it can include a qualified 401(k) plan as a benefit.

Election changes

Elections are made before the period of coverage and are generally fixed. 26 CFR 1.125-4(a) (as of 1 Oct 2026, retrieved 14 Oct 2026) states that a cafeteria plan “may permit an employee to revoke an election during a period of coverage and to make a new election only as provided in paragraphs (b) through (g),” and that section 125 does not require a plan to permit any of these changes. Publication 969 (FSA section, retrieved 14 Oct 2026) likewise says an employee can change or revoke an election only if specifically allowed by law and the plan.

The categories in 1.125-4 are: special enrollment rights under group health plans (paragraph (b)); changes in status (paragraph (c)), whose listed events cover legal marital status, number of dependents, employment status of the employee, spouse or dependent, a dependent’s eligibility, and a change in residence, subject to a consistency rule that the election change must correspond with the status change; a judgment, decree or order (d); entitlement to Medicare or Medicaid (e); significant cost or coverage changes (f); and FMLA leave (g). Paragraph (f) states that it does not apply to an election change for a health FSA. 26 CFR 1.125-3 (retrieved 14 Oct 2026) separately addresses how FMLA leave affects cafeteria-plan elections; see the FMLA employer guide.

Nondiscrimination testing categories

26 U.S.C. 125(b) (retrieved 14 Oct 2026) provides that highly compensated participants lose the exclusion for a plan year in which the plan discriminates in favor of highly compensated individuals as to eligibility to participate, or in favor of highly compensated participants as to contributions and benefits, and that key employees lose it if qualified benefits provided to key employees exceed 25 percent of the aggregate for all employees. Section 125(g) adds special rules, including a collectively bargained plan not being treated as discriminatory, a health-benefits safe harbor based on contribution levels, and a participation-eligibility rule capped at three years of employment.

Publication 15-B (Cafeteria Plans, retrieved 14 Oct 2026) summarises the same categories: plans that favor highly compensated employees as to eligibility, contributions or benefits, and plans that favor key employees (more than 25 percent of nontaxable benefits going to key employees). For 2026 it states that a key employee is generally an officer with annual pay of more than $235,000, a 5 percent owner, or a 1 percent owner with annual pay of more than $150,000. It also describes a “simple cafeteria plan” for employers with an average of 100 or fewer employees that is treated as meeting the nondiscrimination requirements if contribution and eligibility conditions are met. Whether a given plan passes is a facts-and-circumstances test for a professional, not something this page decides.

HSA and health FSA: the differences that matter

Eligibility. Publication 969 (HSAs, retrieved 14 Oct 2026) states that to contribute to an HSA a person must be covered under a high deductible health plan (HDHP) on the first day of the month, have no other health coverage except what is permitted, not be enrolled in Medicare, and not be claimed as a dependent on someone else’s return. It adds that an employee covered by an HDHP and a health FSA or HRA that pays or reimburses qualified medical expenses “can’t generally make contributions to an HSA,” while a limited-purpose or post-deductible health FSA or HRA is permitted, and that coverage during a grace period by a general purpose health FSA is allowed only if the prior-year balance is zero.

Ownership and portability. Publication 15-B states an HSA is owned by the qualified individual, and that contributions by the employer “become the employee’s property and can’t be withdrawn by you.” Publication 969 states an HSA “is ‘portable’” and stays with the person if they change employers. A health FSA, by contrast, is described in Publication 969 as an employer-established benefit plan, typically offered through a cafeteria plan, funded by voluntary salary reduction, whose reimbursements are for expenses incurred during the period of coverage.

Use-or-lose, grace period and carryover. Publication 969 (Balance in an FSA, retrieved 14 Oct 2026) states that FSAs are generally “use-it-or-lose-it,” that a plan can provide either a grace period of up to 2 1/2 months or a carryover, and that a plan adopting a carryover cannot also provide a grace period for a health FSA. It states the plan may specify a lower carryover amount than the maximum and that unused amounts above the carryover are forfeited. HSA balances, by comparison, “remain in your account until you use them.”

Employer contributions and testing. Publication 969 states comparability rules require employer HSA contributions to be the same amount or the same percentage of the HDHP deductible for comparable participating employees, with a 35 percent excise tax on non-comparable contributions, and that “the comparability rules don’t apply to contributions made through a cafeteria plan.” Publication 15-B adds that cafeteria plan nondiscrimination rules still apply to those contributions, and that they cannot be greater for higher-paid employees than for lower-paid employees.

Stated annual limits

The table below gives figures for calendar or plan year 2026 as stated on IRS pages retrieved 14 October 2026. Confirm current-year limits on IRS.gov before using any figure: they are inflation-adjusted annually and we did not locate a 2027 revenue procedure. Publication 969 on the IRS site is written for 2025 and itself states the 2025 figures ($4,300 self-only and $8,550 family HSA; $3,300 health FSA with a $660 maximum carryover) alongside the 2026 figures.

Sources for the 2026 figures: Rev. Proc. 2025-19 (IRB 2025-21) for HSAs, Rev. Proc. 2025-32 section 4.15 for the health FSA, and Publication 15-B What’s New, which restates the FSA cap.

Level-funded and self-funded plans

The sources we read for this page do not address level-funded or self-funded arrangements by name. Publication 969’s HDHP rules are stated in terms of a “health plan” with a minimum deductible and an out-of-pocket maximum, and Publication 15-B states HSA eligibility the same way, so whether a specific level-funded design meets the HDHP definition is a plan-by-plan question for counsel or the plan’s advisor. Funding structure is covered, without HSA conclusions, in level-funded health plans.

Where this sits: nondiscrimination testing for a cafeteria plan sits alongside the plan documents, summary plan description and annual reporting covered in the ERISA and Form 5500 guide, and a health FSA is itself a group health plan for continuation-coverage purposes in the COBRA employer guide.

Where this sits: a 401(k) plan can be offered as a qualified benefit in a cafeteria plan, per Publication 15-B above; the retirement plan’s own testing, limits and deposit rules are in the 401(k) employer requirements guide.

What we could not confirm

The eCFR versioner API returned no content for 26 CFR 1.125-1, 1.125-2, 1.125-5 and 1.125-6 on the date used, so we cannot quote the regulation’s own contents on what a written plan document must include, the plan-year rule, or the uniform-coverage and substantiation details; we relied on the statute and Publication 15-B for the written-plan point. The IRS cafeteria-plan landing page URLs we tried returned 404. We did not read Notice 2012-40, Notice 2013-71 or Notice 2020-33 directly (Publications 15-B and 969 cite them), the dependent care FSA rules, or any state rule. We located no 2027 limits. No primary page we read says how an HSA or FSA interacts with a level-funded plan specifically.