Insurance: Don't try this in your 401(k) plan

June 20, 2008

A company told its employees they could use contributions to their 401(k) plan to pay for long-term-care insurance premiums. The IRS said this wouldn't work.

A company that wanted to provide long-term-care insurance for its employees came up with this nifty idea: Staff members could use contributions to their 401(k) plan to pay for the insurance premiums. This would allow them to fund the premiums with pre-tax dollars and later receive tax-free benefits, which would be classified as reimbursements for medical expenses. In a ruling discussed in the May issue of J.K. Lasser's Monthly Tax Letter, the IRS said this wouldn't work because money in a qualified retirement plan like a 401(k) can't be used to pay for accident, health, or long-term-care insurance. Worse, any company that attempts to allow employees to fund insurance premiums in this manner would be violating the rules on early distributions and could risk having the entire plan disqualified.