INSURANCE 101: The Mental Health Parity and Addiction Equity Act

As defined by the Centers for Medicare & Medicaid Services, the Mental Health Parity and Addiction Equity Act of 2008 (MHPAEA) is a federal law that generally prevents group health plans and health insurance issuers that provide mental health or substance use disorder (MH/SUD) benefits from imposing less favorable benefit limitations on those benefits than on medical/surgical benefits.

MHPAEA originally applied to group health plans and group health insurance coverage and was amended by the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively referred to as the “Affordable Care Act”) to also apply to individual health insurance coverage.

The US Department of Health and Human Services (HHS) has jurisdiction over public sector group health plans (referred to as “non-Federal governmental plans”), while the Departments of Labor and the Treasury have jurisdiction over private group health plans.

Insurance 101: Taxation of Life Insurance Benefits

Favorable Tax Treatment of Personal Life Insurance and Annuities

The Internal Revenue Service administers and regulates taxation on life insurance, annuities, endowments and other retirement funds, including individual retirement accounts.  Having a basic understanding of the various taxes involved with these contracts is important in understanding their structure and how they qualify (or don’t qualify) for favorable tax treatment by the IRS.

Knowing how taxation is levied on each type of contract can be understood through how the money within these contracts is exchanged.  When a ‘taxable event’ occurs, the IRS levies an ordinary income tax on the money being exchanged as these events result in actual income being earned on behalf of a policyowner or beneficiary (based on the death benefit payout) and distributed as income payments.

Policy Funding and Accumulation
Neither life insurance nor annuity premiums are tax deductible for any type of life insurance policy or annuity, except for a percentage of an individual’s contribution in an individual retirement account or individual retirement annuity.

Interest earned on a life insurance policy is part of the policy’s ‘cash value accumulation,’ and is considered deferred income, taxed only when policy funds are distributed from the investment.  Allowing interest to grow at a compounded rate without taxation over the policyowner’s lifetime provides a much greater return on the invested funds.

Similarly, while in the accumulation period, an annuity accumulates earnings on a tax-deferred basis since funds are reinvested into the annuity and not distributed to the policyowner.  Again, the annuity accumulates cash value through principal and earned interest and is considered deferred income, tax-deferred until the fund annuitizes and begins distributing income to the annuitant.

Cash Value Increases
Compared to most investments which are taxed as ordinary income on an annual basis, life insurance provides individuals a means of tax-deferred growth.  In addition, most investment distributions are taxed as ordinary income to the beneficiary of the contract in the event of the contract owner’s death.  Life insurance, in comparison, provides the policyowner’s beneficiary with a tax-free distribution of the death benefit. 

Although most individuals purchase life insurance to provide future financial protection for their survivors’ well-being, it provides an attractive return on investment, in addition to receiving favorable tax treatment, and can be misused as a ‘tax shelter’ for funds that should otherwise be taxed as earned income. 

To curb the increase in life insurance as an investment vehicle and tax shelter, Congress has created a set of tests for a life insurance policy to qualify for a tax advantage and avoid the tax-shelter scenario.

CVAT vs. GPT

Cash Value Accumulation Test (CVAT)
Using the cash value accumulation test, the policy’s cash value must not exceed the amount that would be required as a lump-sum premium to fully pay off the policy based on the policy’s face amount, based on the age of the insured.

Guideline Premium Test (GPT)
Using the guideline premium test, the policy’s premiums cannot exceed the amount that would be required to fully pay off the policy based on the policy’s face amount, as well as the age of the insured.

The primary difference between the cash value accumulation test (CVAT) and the guideline premium test (GPT) is that the CVAT pertains to cash value limits relative to the policy’s death benefit, while the GPT pertains on premium limits relative to the policy’s death benefit.  If the cash value or premiums paid exceed the amount allowable under either test, the policy is no longer considered life insurance and is taxed the same as an investment (as ordinary income).

Again, these tests are guidelines to ensure that a policy continues to qualify as life insurance and receive favorable tax treatment.  If a policy does not pass one of the two tests required by the IRS, it is not considered to be true life insurance and is taxed the same as a non-qualified investment plan; although, most insurers provide notice to their policyowners before such an event occurs to avoid this taxation issue.

While most individuals never contribute amounts high enough to require the use of these tests, the IRS uses these tests to prohibit investors from potentially exploiting the tax advantages associated with true life insurance.

Dividend Returns
Dividends paid out to participating policyowners in a mutual life insurance contract are considered to be a reimbursement of premium paid to the insurer and are paid back on a tax-free basis; however, any interest paid to policyowners in addition to the premium reimbursement is considered to be income and is taxable.

Policy Loans
Another tax advantage associated with life insurance is the ability to withdraw funds in the form of a policy loan without being taxed.  Since a loan must be paid back, including accrued interest, it is not taxed; however, if the policyowner surrenders his or her policy, an income tax is levied against any gain in the policy’s loan value amount. 

If the policyowner dies before repayment of the loan, the policy’s death benefit is reduced by the amount of outstanding loan and accrued interest, with the remainder lump sum being tax-free for the beneficiary (unless a recurring payment option is selected). 

Policy Settlement Options

Policy surrenders
In the event that a policyowner surrenders his or her policy to the insurer, proceeds equaling the premium paid into the policy are tax-free, while policy surrender proceeds that exceed the cost of the policy are taxable by the IRS.  Any pre-tax premium payments and interest earned before forfeiting the plan are taxable as earned income.

Accelerated benefits and Viatical settlements
Under current laws, as long as a policyowner is considered to be chronically or terminally ill, both accelerated benefits and policy proceeds from a viatical settlement are paid out on a tax-free basis.

Death Benefit Proceeds
Death benefit proceeds are paid income tax-free to a policy’s beneficiary if it is paid out as a lump-sum amount.  If the beneficiary elects to receive continual income payments, or ‘installments,’ from the death benefit, instead of the lump-sum amount, only the interest that accrues from the principal is taxed as ordinary income to the beneficiary, but not the actual death benefit amount.

Group Life Insurance
Group life insurance includes certain tax advantages for businesses as a means of promoting group insurance for employees.  Premiums paid by the employer are tax deductible for the employer as a form of business expense.

In a group life policy, employee premium contributions are not tax deductible; however, employees do not need to report their employer-paid premiums as income as long as their policy coverage is $50,000 or less.  This is due to the fact that policy premium payments by the employer are not considered income to the employee up to the first $50,000.  If, however, the policy coverage exceeds $50,000, the employee is taxed on any excess premium above this limit, as this amount is considered taxable annual income.

Group policy death benefit proceeds are similar to individual policies where the benefit is tax-free if taken as a lump-sum by the beneficiary.  If installment benefits are chosen by the beneficiary, any interest earned on principal is considered earnings and is taxed accordingly.

Values Included in an Insured’s Estate
Upon the death of an insured individual in a life insurance policy, federal and state inheritance estate taxes are mandated for policy proceeds that are included in the estate of the insured. 

To avoid this estate tax, the insured can transfer ownership of his or her life contract to the designated beneficiary, but the transfer must be completed at least three years before the death of the insured.  Under the ‘three-year look back’ rule, the IRS can still levy estate taxes on the insured’s estate if a transfer of ownership to the beneficiary occurs within three years of the insured’s death.

INSURANCE 101: Omnibus Budget Reconciliation Act (OBRA)

Enacted in 1989, the Omnibus Budget Reconciliation Act, also referred to as OBRA, extends COBRA continuation benefits from 18 months to 29 months for disabled employees at the time of the qualifying event or who become disabled during the first 60 days of COBRA coverage who do not already qualify for 36 months under COBRA.

The Omnibus Budget Reconciliation Act (OBRA) also clarified Medicare as an ‘entitlement’ program which allows eligible Medicare recipients to sign up for Medicare coverage before becoming disqualified and thus losing continuing health coverage through COBRA or OBRA.

INSURANCE 101: Consolidated Omnibus Budget Reconciliation Act (COBRA)

Enacted in 1985, the Consolidated Omnibus Budget Reconciliation Act, also referred to as COBRA, extends group health coverage to former employees and their families for up to 18 or 36 months after termination of employment. Under this federal law, an employer group must consist of at least 20 employees.

The premium rate under COBRA remains the same for the terminated individual as it was while the individual was covered under the group policy; however, the terminated employee typically begins paying the entire premium, often paying more than when he or she was covered under the group policy.  Often times this increase in payment is confused for an increase in the premium rate, but in actuality, the increased amount paid by the individual is a result of the employer ceasing contributions to the individual’s premium once he or she is terminated from group coverage. Under COBRA, the terminated employee is responsible for paying the entire premium rate for his or her policy.

Terms and Limitations of COBRA
Qualifying for COBRA occurs when the employee, spouse, or dependent child becomes ineligible for coverage under the group insurance. Examples include family coverage after the death of a covered employee, termination of employment or reduction of hours under full-time status, Medicare eligibility, legal separation spousal coverage, child ineligibility on the group plan, or if the employer declares bankruptcy and employment ends. Employee termination resulting from misconduct does NOT qualify under COBRA.

A qualified beneficiary is considered to be anyone covered under the group policy the day before the qualifying event occurs and normally includes the employee, spouse, and dependent children.

A written eligibility notification, also known as a Notification Statement, must be given to employees, their spouses and any other dependents on the policy by the employer when the employee group becomes eligible for COBRA coverage, or when a qualifying event occurs.  Federal law requires a 60-day period to elect COBRA coverage, after which the employee is no longer eligible.

The purpose of continuation coverage is to provide time for the terminated employee to either apply for new coverage under a new group plan or apply individually (or become eligible for Medicare).

Qualifying Events for 18 Months of COBRA

• Termination of employment (most common)
• Hours of employment are reduced

When an employee’s position within a company is terminated, or when an employee’s hours are reduced below the minimum required to be eligible through the employers’ group policy, he or she is removed from the company’s group health policy.  The additional 18 months provided under COBRA provides this employee with time to find new coverage.

Qualifying Events for 36 Months of COBRA

• Coverage for surviving dependents of a deceased employee
• Former spouse of an employee after legal separation or divorce
• Dependent children that no longer qualify as dependent

COBRA coverage ends when a disqualifying event occurs such as failure to pay premium, Medicare entitlement, or once new insurance is issued.

INSURANCE 101: Pregnancy Discrimination

Enacted in 1973 as a result of the Civil Rights Act, the Pregnancy Discrimination Act, prohibits employers with fifteen (15) or more employees, as well as all state and local government employees, from discriminating against pregnant women in regards to childbirth or related medical conditions.

Women who are pregnant or are affected by pregnancy-related medical conditions are covered under this law.  As an exception to this law, costs associated with abortion are not required to be covered, unless the life of the mother is endangered.

Under this law, pregnant employees must be able to continue to work for as long as they are able to perform their work duties, and employers are prohibited from requiring any set period of time off after childbirth before allowing the woman to return to work.

Employer-sponsored health insurance must cover expenses for pregnancy-related conditions on the same basis as for other medical conditions and cannot require any additional or increased deductible amount.  Employers must provide the same coverage for the spouse of a male employee as they do for the spouse of a female employee.

INSURANCE 101: Family and Medical Leave Act (FMLA)

Enacted in 1993, the Family and Medical Leave Act, also referred to as the FMLA, provides ‘eligible’ employees with the ability to take an unpaid leave of absence of up to twelve (12) workweeks during any 12-month period for certain qualified medical, family and military reasons.  An employee becomes eligible for FMLA protection upon being employed by the same employer for at least one (1) year and has worked for 1,250 hours over the previous 12 months.

Under this Act, employers are required to maintain the employee’s health coverage under the employer’s group health plan as well as any other employment benefits in the absence of the employee.  In addition, an employer must accept an employee back to the company after a qualified FMLA period of absence for the same or an equivalent job position as before taking such leave of absence.

The Department of Labor provides 12 weeks of unpaid, job-protected coverage under FMLA for the following reasons:

• The incapacity of the employee due to pregnancy, prenatal medical care or child birth as well as to care for the employee’s child after birth, or adoption
• A serious health condition that makes the employee unable to perform the essential functions of his or her job
• To care for the employee’s spouse, child or parent who has a serious health condition

As defined under the FMLA, a ‘serious health condition’ is an illness, injury, impairment or physical or mental condition that involves either an overnight stay in a medical care facility, or continuing treatment by a health care provider for a condition that either prevents the employee from performing the functions of the employee’s job, or prevents the qualified family member from participating in school or other daily activities.

Enforced by the Department of Labor, all State and Federal agencies and employers, as well as private employers with 50 or more employees within 75 miles of the employer must provide such employment protection.  Eligible employees are responsible for providing sufficient information and documentation pertaining to a need for a leave of absence and should provide advance notice, when possible, of 30 days before needing to take such leave from employment.

INSURANCE 101: Taxation of Health Insurance

Taxation of Individual Health Insurance

Medical Expense Insurance Premiums and Benefits
Medical expenses that are covered through an insurance policy, such as an operation or the cost of services for a doctor’s visit, are considered ‘reimbursed’ medical expenses and cannot be deducted from a policyholder’s annual income.

Medical expenses that are not covered through an insurance policy, such as policy premiums, deductibles, copays, coinsurance amounts, and medical expenses not reimbursed through the policy, are considered ‘unreimbursed’ medical expenses.

Unlike reimbursed medical expenses which cannot be deducted, unreimbursed medical expenses can be deducted only if the policyholder’s annual unreimbursed medical expenses exceed 10% of his or her adjusted gross annual income.  If he or she exceeds this 10% threshold, only the excess of 10% will be considered tax deductible.

Example 1

Tim’s unreimbursed medical expenses equal $4,500 and his adjusted gross income for the year is $50,000.  Based on his adjusted gross income, he would not be able to deduct any unreimbursed medical expenses because he did not exceed the 10% or $5,000 ($50,000 x 10% = $5,000) threshold.

Remember, if the policyholder’s annual unreimbursed medical expenses do not exceed 10% of his or her adjusted gross annual income, none of the unreimbursed medical expenses are deductible.

Example 2

Tim’s unreimbursed medical expenses equal $4,500 and his adjusted gross income for the year is $40,000.  Based on his adjusted gross income, he would exceed the 10% ($40,000 x 10% = $4,000) threshold and would be able to deduct $500 ($4,500 – $4,000 = $500) of his unreimbursed medical expenses.

Note: Individuals born before January 2, 1950 can deduct annual unreimbursed medical expenses that exceed 7.5% of their adjusted gross annual income, as opposed to 10% for individuals born on or after this date.

Medical expense policy benefits are received tax-free by the insured; however, it is important to note that medical expense benefits cannot exceed actual medical expenses incurred by the insured.

Long-term Care Insurance Premiums and Benefits

Both medical expense and long-term care policy premiums are considered medical expenses, and are included in annual deductions when meeting the 10% or 7.5% unreimbursed medical expense thresholds.

LTC benefits are received income tax-free by the insured up to the amount of incurred expenses.  Any benefits exceeding the actual costs by the insured are considered taxable, as is the case under a fixed benefit LTC policy when daily benefits payable exceed daily expenses incurred.

The 10% and 7.5% expense limits apply to medical expense and long-term care policies, but do not apply to disability insurance.

Disability Insurance Premiums and Benefits

Premiums paid for individual disability insurance are not tax deductible from a policyholder’s annual income; however, disability income payments are received income tax-free by the insured and are usually expressed as a percentage of the insured’s pre-disability income amount.

Disability benefits cannot exceed pre-disability income levels and are often paid out as a percentage of the insured’s actual pre-disability income amount to encourage the individual to return back to work as soon as possible to reach his or her full pre-disability earnings.

Individuals who are considered chronically ill must be re-certified as such by their insurer on an annual basis to continue to receive disability benefits on a long-term basis.

Taxation of Group Health Insurance
Employer-based group health insurance represents the majority of the health insurance in America.  Many employers provide health insurance in the form of medical expense coverage, LTC and disability income policies for employees as a benefit of employment.

Group Medical Expense Insurance Premiums and Benefits

Employee-paid premium contributions in a group medical expense policy are not tax deductible; however, employer-paid premium contributions in a group policy are not taxable to the employee and are not included in an employee’s annual income, thus lowering the employee’s taxable income.

Employee medical expense benefits are received income tax-free, but benefits cannot exceed actual expenses.

Similar to personal excess medical expenses, if an employee’s annual unreimbursed medical expenses exceed 10% of his or her adjusted gross annual income (7.5% for individuals born before January 2, 1950), any unreimbursed medical expenses that exceed this 10% (or 7.5%) are deductible from the employee’s annual income.

Group Long-term Care Insurance Premiums and Benefits

Employee-paid premium contributions in a group long-term care policy are not tax deductible; however, employer-paid premium contributions in a group policy are not taxable to the employee and are not included in an employee’s annual income, thus lowering the employee’s taxable income.

LTC benefits are received income tax-free by the insured up to the amount of incurred expenses.  Any benefits exceeding the actual costs by the insured are considered taxable, as is the case under a fixed benefit LTC policy when daily benefits payable exceed daily expenses incurred.

Similar to personal excess LTC expenses, if an employee’s annual unreimbursed LTC expenses exceed 10% of his or her adjusted gross annual income (7.5% for individuals born before January 2, 1950), any unreimbursed LTC expenses that exceed this 10% (or 7.5%) are deductible from the employee’s annual income.

Group Disability and AD&D Insurance Premiums and Benefits

Employee-paid premium contributions in a group or franchise disability or AD&D policy are not tax deductible; however, employer-paid premium contributions are not taxable to the employee and are not included in an employee’s annual income, thus lowering the employee’s taxable income.

Employee AD&D benefits are received income tax-free; however, an employee’s disability income (DI) benefits are received income tax-free in proportion to the benefits that represent the employee’s premium contributions.  This means that the employee’s disability income benefits are taxed as income to the employee in proportion to the benefits that represent the employer’s premium contributions to the policy.

As an example, If an employer pays 100% of the group disability insurance premium for its employees (100% employer contribution), then benefits are 100% taxable as income to the employees; if however, the employer pays 50% and the employee pays the other 50% of the premiums, only the portion of benefits that is attributed to the employer’s premium payment is taxable as income to the employee.  Although employees’ premium contributions are not tax deductible from annual income, their 50% paid portion of disability income benefits is received income tax-free.

As a final example, if the employees contribute 100% of the premium payments toward their group disability policy, then 100% of the disability income is received income tax-free for the employees.

FICA Taxation
As is the case with ordinary income, employees are also responsible for paying Social Security FICA taxes on the portion of disability income earned under the DI policy that was funded by the employer’s premium contributions for a 6 month period following the beginning of the DI benefit period, since this portion is considered to be earned income by the employee and would otherwise be taxed as part of the employee’s payroll under FICA.

Group Sponsor Taxation

Employer Taxation
Employer-paid premium contributions for group medical expense, disability and AD&D policies are all deductible as a business expense for the company because they serve as otherwise ordinary income that would be paid to the employee.  Except for cafeteria plans or flexible spending accounts, LTC policies are also deductible as a business expense for the company.

Small business overhead expenses (BOE) are tax deductible as a business expense whether it is a self-employed sole proprietorship, partnership, or corporation.

Self-Employed Taxation
Self-employed individuals, sole proprietors, and partnerships can deduct 100% of their annual unreimbursed medical expenses, however, disability insurance taxation rules apply the same as they do for individual DI policies (taxable premiums and tax-free benefits).

Key Person Taxation
In regards to a ‘key person’ disability income policy or a partnership ‘buy-sell’ disability policy, since the business is providing protection for itself against the loss of one of its key executives or members, the company’s premiums are not tax deductible as a business expense; however, benefits are received income tax-free to the business.

Taxation of Health Spending Accounts

Health Savings Account (HSA)
An HSA is a popular type of medical expense savings account is used both personally, as well as in a group health policy to help control premium costs and to provide better management of an individual’s health needs.   Pre-tax employer contributions, as well as after-tax personal contributions are deposited into the HSA, enabling it to grow tax free just like an ordinary savings account.  Pre-tax contributions are taxable as income upon distribution followed by the reimbursement of any after-tax contributions.

Employer contributions to an employee’s HSA are excluded from an employee’s taxable income, thus lowering the employee’s taxable income.  In addition to the tax-deferred earned interest of an HSA, an insured can withdraw funds from the account on a tax-free basis for ‘qualified’ medical expenses such as unpaid hospital or Medicare expenses, doctor’s fees and prescription costs, as well as other costs outlined in the HSA contract.

Unqualified withdrawals from an HSA before the age of 65 years old are subject to ordinary income taxation, as well as a 20% ‘early withdrawal’ penalty tax.  HSA distributions made once the individual reaches 65 years old are only subject to ordinary income taxation for the year in which they are received by the insured.

Health Reimbursement Account (HRA)
The IRS levies similar taxation on an HRA as it does with an HSA.  Employer contributions to an employee’s HRA are considered to be tax deductible as a business expense for the company because they serve as otherwise ordinary income that would be paid to the employee.

Employee-paid premium contributions in an HRA are not tax deductible; however, employer-paid premium contributions in an HRA are not taxable to the employee and are not included in an employee’s annual income, thus lowering the employee’s taxable income.  Employee benefits received through the HRA are received income tax-free.