Corporate Compensation Plans Says Treasury Torpedoes Key 401k Benefit

DANBURY, Conn.--(BUSINESS WIRE)--The Treasury has effectively killed a key 401k benefit that allows 401k participants to buy disability insurance with their 401k contributions. When the participants become disabled the insurance continues their contributions directly into their 401k accounts so their assets will grow just as if they were working. Here’s the background:

The biggest threat to employees’ retirement security is a career ending disability because, in that event, contributions to their 401k plans stop with the potential for catastrophic losses in their projected retirement benefits at age 65. For example:

Loss of 401k Assets due to a disability
				Loss of Assets
	Age Disabled	Annual 401k Contribution*		at age 65 @5.5%
	35		$20,000	$1,528,389
	45		$20,000	$ 735,722
	55		$20,000	$ 271,670
	* Includes both employer and employee contributions.

The IRS, recognizing the seriousness of this problem, issued two Private Letter Rulings ⁽¹⁾ that enabled 401k participants to purchase disability insurance that continues their contributions directly into their 401k accounts when they became disabled. As a result, major insurance companies designed a special group disability policy for the 401k-plan market and IBM was the first large company to make the program available to its 401k plan participants.

Inexplicably in 2007 the Treasury proposed regulations ⁽²⁾ that, if adopted, would effectively revoke their prior Private Letter Rulings. Several organizations filed objections and recommended that the regulations incorporate this benefit. However, these regulations have still not been finalized and, as a result, employers are hesitant to offer this vitally important benefit to their 401k plan participants because of the tax uncertainty surrounding it.

At this point, it is unclear when the Treasury will finalize the proposed regulation or whether it will relax the effective prohibition against 401k disability protection. The result is that some 60 million 401k plan participants are being deprived of their ability to protect themselves against a disability – even though 1 in 7 of them can expect to be disabled for 5 years or more before retirement ⁽³⁾.

Further, this threat has been compounded by the severe losses almost all 401k plan participants have suffered in recent years because of the bear market in stocks.

In all fairness to the Treasury, it has been burdened with the unprecedented workload thrown upon it because of the results of the recession, the new Health Insurance regulation, and the re-assignment of some of its personnel. However, given the severe thereat of a disability to almost every 401k participant’s financial security, exempting the 401k-disability plan from its proposed regulations should be a Treasury priority.

Note, in the interest of full disclosure, Corporate Compensation Plans is an insurance broker and has a vested interest in being able to market 401k insurance to its clients and prospects.

(1)	Private Letter Rulings 200031060 and 200235043.
(2)	Federal Register, 8/20/2007 26CFR Part 1 RE-148393 (At a meeting with Treasury officials in December of 2007 a number of interested parties protested the Treasury action. They pointed out that protecting employees’ 401k plans against disability was primarily a social and not a tax issue. They also pointed out that the disability plan was cost-neutral to the Treasury as the disability benefits would be taxable when distributed from the 401k plans. Their strong recommendation was that 401 -disability protection be exempted from the regulations. They also noted that many defined benefit pension plans contain disability protection so that when participants become disabled, their pension benefits continue to accrue. However defined benefit pension plans are being terminated at an increasing rate and the 401k plan has become, by default, the retirement plan of choice.)
(3)	The Council for Disability Awareness – 2007.