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Using 401(k) Funds to Purchase Long-Term Care Insurance is Prohibited

    Client Alerts
  • February 29, 2008

An EmployNews article last summer (link) highlighted proposed regulations relating to the payment of a participant’s premiums for accident, health or long-term care insurance premiums from his account under a qualified plan.  Under those regulations, such payment generally would be treated as an in-service distribution to the participant of the amount of the premium payment and could be subject to the 10% excise tax on early distributions.  While the proposed regulations indicated they were not expected to apply until after the publication of final regulations, they also stated that “no inference should be drawn that the payment of premiums from a qualified plan does not constitute a taxable distribution if made prior to the effective date of these regulations.”  Based on a recently published private letter ruling (PLR), it appears plan sponsors should err on the side that the proposed regulations are effective now.


In the PLR, a 401(k) plan sponsor proposed making long-term care insurance an available investment option for participants’ elective contribution and employer non-elective contribution accounts.  Even though the sponsor’s proposed design was intended to comply with guidance on “incidental benefits” and distribution and anti-alienation restrictions, the IRS nonetheless cited the proposed regulations in ruling that the arrangement would result in treating the premiums paid by the plan as taxable distributions to participants.  Further, since elective contributions to a 401(k) plan can be distributed only upon severance from employment, death, disability, plan termination, attainment of age 59½ or hardship, premium payments made from elective contributions could be treated as impermissible in-service distributions and could result in plan disqualification.


Based on the PLR and the IRS’s application of other guidance in the PLR, including the proposed regulations, sponsors of qualified retirement plans that allow payment of health, disability and/or long-term care insurance premiums should likely begin treating such premium payments as taxable distributions and ensure that the payments are made only on behalf of participants who otherwise qualify for in-service distributions under the plan’s terms.