Final Regulations Allow Retirement Plan Payments for Accident, Health and Disability Insurance

by McDermott Will & Emery
Contact

On May 9, 2014, the Internal Revenue Service finalized regulations that govern the tax treatment of payments made by retirement plans to pay accident or health insurance premiums.  Under the final regulations, accident or health insurance premium payments by qualified defined contribution plans are taxable distributions to the participant unless those payments are used to pay premiums for disability insurance that replace retirement plan contributions for disabled employees.  The regulations apply for tax years beginning January 1, 2015, although taxpayers may elect to apply them to earlier years.

On May 9, 2014, the Internal Revenue Service finalized regulations (Regulations) that govern the tax treatment of payments by retirement plans to pay accident or health insurance premiums.  Under the final Regulations, accident or health insurance premium payments made by qualified defined contribution plans are taxable distributions to the participant.  However, amounts used to pay premiums for disability insurance that will continue retirement plan contributions on behalf of disabled employees are not taxable distributions if they meet certain conditions.

Accident and Health Insurance

In general, employees may make payments for accident and health insurance premiums on a pre-tax basis under Section 125 of the Internal Revenue Code (Code).  The Code also excludes from a participant’s gross income payments received from accident or health insurance for injuries or sickness.  However, under Code Section 402(a), distributions from retirement plans are included in a participant’s gross income and taxable in the tax year of distribution. 

Consistent with the proposed rules issued in 2007, the final Regulations clarify that payments made by qualified defined contribution plans to pay accident or health insurance premiums are taxable distributions under Code Section 402(a), unless a statutory exclusion applies (see below).  The distributions are taxable to the participant in the year in which the premiums are paid.  The taxable amount of the distribution is the amount of the premium charged against the participant’s benefits under the plan.  Additionally, premium payments that are paid from unallocated contributions or forfeitures are also taxable distributions.  Those premiums will be treated as though they were first allocated to the participant and then charged against the participant’s benefits.  Money subsequently received from the accident or health insurance for personal injuries or sickness remains excluded from gross income under the final rules.

A statutory exclusion to the inclusion in gross is for payments of accident or health benefits from a qualified retiree health account described in Code Section 401(h) for retired employees under a pension or annuity plan.  These amounts are excluded from the employee’s gross income to the extent they also are excluded under Code Sections 104, 105 or 106.  Another exception is the exclusion from gross income of up to $3,000 annually for direct payments made to an insurer to purchase accident or health insurance or qualified long-term care insurance for eligible retired public safety officers under Code Section 402(l).

Disability Insurance

The proposed regulations asked for comments regarding how payments for disability insurance premiums should be treated in the final rules.  The preamble to the final Regulations states that every comment submitted suggested that premium payments should be tax free if they replace a participant’s contributions to the plan.  Many commenters argued that a qualified plan’s premium payments for the purchase of disability insurance are distinguishable from the purchase of medical insurance because disability payments are intended to replace a participant’s contributions to the plan, rather than providing medical benefits outside of the plan.  For this reason, disabled employees should not be taxed when disability payments are sent to their retirement accounts because those contributions will be taxed when the retirement benefits are distributed.

These arguments were largely persuasive.  Accordingly, the final Regulations provide that payments of disability insurance premiums from a qualified plan are not taxable if both of the following conditions are satisfied: 

  • The insurance contract provides for benefit payments to be made to the plan in the event of an employee’s inability to continue employment because of disability 
  • The benefits paid to a participant’s account do not exceed the reasonably expected annual contributions that the employee would have received during the period of disability, reduced by any other contributions made on the employee’s behalf during the disability period

Meeting these conditions results in disability insurance being treated as a plan investment and the plan’s premium payments and the insurance’s benefit payments to the plan are not taxable to the participant.  If these conditions are not met, the premium payments would become taxable distributions to the employee under Code Section 402(a) and benefits paid to the plan would be deemed contributions.

The final regulations were published in the Federal Register on May 12, 2014, and apply to plan years beginning on or after January 1, 2015, though taxpayers may apply them to earlier years.

Next Steps

Employers that sponsor qualified defined contribution plans may consider giving employees the option to purchase disability insurance on a tax-favored basis.  Employees who choose to purchase coverage will have the benefit of knowing contributions to their retirement accounts will continue should they become disabled and unable to continue working.  Employers will need to review the terms of their plans to determine if adding disability insurance will require a plan amendment.

 

Written by:

McDermott Will & Emery
Contact
more
less

McDermott Will & Emery on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!