The final regulations 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. Payments from a qualified defined contribution plan to pay a participant’s disability insurance premiums are not 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.
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 are paid from a qualified retiree health account (IRC Section 401(h)), or for qualified public safety officers (IRC Section 402(l)).
The final regulations include an exception for disability insurance premiums being taxed to participants if the following conditions are met:
- Premiums for the disability insurance contract are paid directly from the plan;
- The plan receives the benefit payments as required by the disability insurance contract;
- Benefit payments under the contract are paid because of an employee’s inability to continue employment with the employer because of disability; and
- The benefit payments to a participant’s account are not more than a reasonable expectation of what the participant would have 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 are not taxable to the participant.
If the disability insurance premiums are not paid by the plan, the insurance benefits paid to the plan are not 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 does not 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.