The IRS issued final regulations (T.D. 9665) concerning the tax treatment of qualified retirement plan distributions used to pay premiums for accident, health and disability insurance. The final regulations provide that payments from a qualified plan to pay a participant's accident or health insurance premiums are taxable distributions unless they are paid (1) from a qualified retiree health account or (2) for qualified public safety officers.
The final regulations include an exception for disability insurance premiums being taxed to participants if all of the following conditions are met:
- The 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.
- 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 the conditions listed above are satisfied, the disability insurance is considered a plan investment, and the plan's premium payments and the insurance 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 under Section 415(c)). If an employer self-insures the disability coverage, 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.
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