In Employee Plans News, Issue 2014-8, May 16, 2014, the Internal Revenue Service (the “IRS”) provides guidance on retirement plan payments for accident, health and disability. Here is what the IRS said:
Final regulations. Final regulations (T.D. 9665) state that payments from a qualified defined contribution plan to pay a participant’s:
• accident and health insurance premiums are taxable distributions to the participant unless a statutory exception applies (Internal Revenue Code Sections 72 and 402(a)), and
• disability insurance premiums aren’t taxable distributions if they meet certain conditions.
The regulations finalize the 2007 proposed regulations and add the exception for disability insurance coverage; they are effective January 1, 2015, but may be applied earlier.
Accident and health insurance. The 2007 proposed regulations stated the general rule that payments from a qualified plan to pay a participant’s accident or health insurance premiums are taxable distributions unless they’re paid:
• from a qualified retiree health account (IRC Section 401(h)), or
• for qualified public safety officers (IRC Section 402(l)).
Disability insurance. The final regulations include an exception for disability insurance premiums being taxed to participants if the following conditions are met:
1. Premiums for the disability insurance contract are paid directly from the plan.
2. The plan receives the benefit payments as required by the disability insurance contract.
3. Benefit payments under the contract are paid because of an employee’s inability to continue employment with the employer because of disability.
4. The benefit payments to a participant’s account aren’t more than a reasonable expectation of what the participant would’ve received as an annual contribution during the disability period, reduced by any other contributions.
If these conditions are satisfied, the disability insurance is considered a plan investment, and the plan’s premium payments and the insurance’s benefit payments to the plan aren’t taxable to the participant.
If the disability insurance premiums aren’t paid by the plan, the insurance benefits paid to the plan aren’t a return on a plan investment. Instead, these payments are contributions to the plan governed by qualified plan contribution rules (generally, IRC Section 415(c), which limits employer contributions to a defined contribution plan).
If an employer self-insures this disability coverage (or doesn’t finance it through third party insurance), the amount paid to the plan because of the employee’s disability is also considered a contribution to the plan governed by the general qualified plan contribution rules.