Tax Considerations for ERISA Disability Plans

The Employee Retirement Income Security Act of 1974 (ERISA) is a federal statute that regulates most employer sponsored disability, health and pension plans. Sponsorship means the employer made the plan available to its employees whether or not the employer funded the plan or contributed towards the payment of plan premiums. ERISA plan benefits may be subject to federal income tax depending on how the plan premiums were paid, and this may have a significant effect on the “net” benefits received especially with ERISA disability plans.

Employers often provide benefit plans to their employees through “cafeteria” programs which allow employees to pick and choose among various plans, e.g. medical, dental, prescription, disability, etc. and different levels of coverage. Employers frequently subsidize these plans with spending accounts which employees use to cover the cost of some or all of the plan premiums. Premium balances are paid by the employees who are frequently given the opportunity to pay these amounts with either “pre-tax” or “after-tax” income. Careful consideration should be given to determining how plan premiums are paid especially with disability plans. Generally, disability benefits from employer subsidized plans and/or plans paid with “pre-tax” income are regarded as taxable income while benefits from plans paid with employees’ “after-tax” income are not subject to income tax. This can have a significant and sometimes devastating effect on the “net” benefits employees receive should they become disabled. While employer subsidized and/or “pre-tax” income paid plans may initially save employees some money, the benefits received from these plans may be subject to a significant tax liability. Accordingly, employees should speak with their benefits departments and tax advisors when determining how to best pay disability plan premiums. Also, employees should consider consulting with tax advisors when disability benefits are paid since the determination of what percentage of the benefits are subject to tax can be complex when the plan premiums were partially employer subsidized.