Health Insurance Premium Payments by Qualified Retirement Plans are Taxable Health Insurance Premium Payments by Qualified Retirement Plans are Taxable

Health Insurance Premium Payments by Qualified Retirement Plans are Taxable

On May 9, the Internal Revenue Service (IRS) issued final regulations concerning the tax treatment of payments made by qualified retirement plans for accident or health insurance premiums.  The final regulations generally adopt proposed regulations the IRS issued in August 2007, apply for taxable years beginning on or after January 1, 2015, and affect qualified retirement plan sponsors, administrators, participants and beneficiaries.

Consistent with the proposed regulations, the final regulations clarify that amounts held in a qualified plan that are used to pay accident or health insurance premiums are treated as distributions under Section 402(a) of the Internal Revenue Code (Code) which are taxable to the plan participant in the taxable year in which the premiums are paid.  The taxable amount of the distribution is generally equal to the amount of the premium charged against the participant's benefits under the plan.  In general, such a distribution is not excluded from gross income.  However, the distribution may be considered a payment for medical care under Code Section 213, in which case, the participant may deduct such payment if it was actually paid during the taxable year, and if it exceeds 10 percent of the participant's adjusted gross income.  In addition, to the extent the premium for accident or health insurance constitutes a taxable distribution, amounts received through the accident or health insurance for personal injuries or sickness are excluded from the participant's gross income and not treated as distributions from the plan.

The final regulations treat accident and health insurance premium payments from qualified plans as taxable distributions unless a statutory exclusion applies.  One such exclusion provides that payments of accident or health benefits for retired employees under a pension or annuity plan from an account described in Code Section 401(h) are excluded from a participant's gross income to the extent they are excluded from gross income under Code Sections 104, 105, or 106.  Similarly, Code Section 402(l) provides that distributions paid directly to an insurer to purchase accident or health insurance or qualified long-term care insurance for an eligible retired public safety officer and his or her spouse or dependents (in amounts up to $3,000 annually) are excluded from gross income.

In response to comments and requests submitted concerning the proposed regulations, the final regulations include an important exception to the general rule.  The payments a qualified plan makes to an insurance company for disability insurance premiums are not treated as taxable distributions under Code Section 402(a), and instead constitute incidental accident or health insurance, but only if the following conditions are satisfied:

  • the insurance contract provides for payment of benefits to be made to the plan in the event of an employee's inability to continue employment with the employer due to disability, and
  • the payment of benefits with respect to an employee's account does not exceed the reasonable expectation of the annual contributions that would have been made to the plan on the employee's behalf during the period of disability, reduced by any other contributions made on the employee's behalf for the period of disability within the year.
If these conditions are not met, the premium payments made to provide disability benefits to the employee would be treated as taxable distributions to the employee under Code Section 402(a) and benefits paid to the plan would constitute contributions.

The final regulations provide two helpful examples to illustrate how these provisions would be applied in a situation where health insurance premium payments constitute taxable distributions under Code Section 402(a), and a situation where payments for disability insurance premiums are not considered taxable distributions.

If you have any questions or would like additional information about the impact the final regulations have on your qualified plan and the tax treatment of your health insurance premium payments, please contact Mary Beth Braitman, Robert Gauss, Lisa Erb Harrison, Tiffany Sharpley, Malaika Caldwell or any member of Ice Miller's Employee Benefits Group.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.
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