"Payments are not taxable for accident and health insurance if they meet the conditions listed in Section 401(h) generally designed to make sure the retirement plan’s main objective continues to be saving for retirement."
The IRS has finally put an end to the legal ambiguity on whether certain direct payments from a qualified retirement plan to an insurance carrier – for accident, health & disability coverage – are taxable or not.
The answer? In general, yes, they are taxable – but with notable exceptions:
Accident & Health - payments are not taxable for accident and health insurance if they meet the conditions listed in Section 401(h) generally designed to make sure the retirement plan’s main objective continues to be saving for retirement. Here’s the excerpt:
“Section 401(h) provides that a pension or annuity plan may provide for the payment of benefits for sickness, accident, hospitalization, and medical expenses of retired employees, their spouses and their dependents only if certain enumerated conditions are met. Those conditions include: (1) the aggregate actual contributions for medical benefits (when added to actual contributions for life insurance protection under the plan) may not exceed 25 percent of the total actual contributions to the plan (other than contributions to fund past service credits) after the date on which the account is established; (2) a separate account must be established and maintained for such benefits; (3) the employer’s contributions to the separate account must be reasonable and ascertainable; (4) it must be impossible, at any time prior to the satisfaction of all liabilities under the plan to provide such benefits, for any part of the corpus or income of such separate account to be (within the taxable year or thereafter) used for, or diverted to, any purpose other than the providing of such benefits; (5) any amount remaining after satisfaction of all liabilities must, under the terms of the plan, be returned to the employer; and (6) special limitations for the accounts of key employees must be satisfied.”
"Compliance with the new rules isn’t required until 2015, but they can be implemented as of May 12, their publishing date."
Disability – payments are not taxable for disability if the purpose of the disability insurance is to ensure that an employee can continue to make retirement plan contributions while they are disabled. In this case, the plan must satisfy these conditions: 1) premiums are paid directly from the qualified plan, 2)disability benefits received are paid directly to the plan by the insurance carrier to continue funding the disabled employee’s retirement savings, and 3) benefit payments “aren’t more than a reasonable expectation of what the participant would have received as an annual contribution during the disability period, reduced by other contributions,” according to the IRS.
Compliance with the new rules isn’t required until 2015, but they can be implemented as of May 12, their publishing date.
Both exceptions’ conditions are common sense, really. Tax credits are given to encourage behavior, and while the IRS seeks to encourage employees to have accident, health & disability coverage by offering a tax break, they also want to encourage employees to save for retirement, and don’t want retirement savings to be negatively impacted by making insurance payments from employees’ retirement savings pot.
There is also an occupation-specific exception for qualified public safety officers.
Check out the entire Section at: or go read the entire Section at: http://www.irs.gov/irb/2007-39_IRB/ar15.html.
Saving taxes on accident, health & disability payments may be worth a look. It could give you yet another edge in attracting and retaining top flight employees.
Rylan Klaseen & Associates
Rylan Klaseen & Associates
Serving Southern California: