Advantages of Group Term Life Insurance as an Employee Benefit

Tax-favored fringe benefits can help your business attract and retain skilled workers. One benefit that's been around for decades and is typically popular with employees is group term life insurance.

With these plans, part or all of the coverage is tax-free to employees if certain requirements are met. Meanwhile, the cost of premiums is deductible for the employer as long as the plan is offered to all rank-and-file employees. What's more, an employer may "carve out" extra benefits for higher-ups if it so chooses.

life preserver

The Basics

True to its name, group term life insurance provides coverage for a group of employees for a specified number of years. Because employees are insured as a group, the overall cost is less than it would be for individual policies.

As mentioned, group term life insurance must be offered to all eligible employees — in other words, those who have worked a certain number of hours per week or been employed a specified length of time. Participating employees will be covered only while they're employed by the company.

Coverage under group term life policies can vary, but it's typically based on a multiple of each participant's salary. For this purpose, the employer can exclude other forms of compensation, such as bonuses and commissions.

For example, Tom has a salary of $100,000 a year and receives a $10,000 bonus at year end. If the plan's applicable multiple is five, Tom's coverage is extended for a death benefit of $500,000 ($100,000 times 5), not $550,000 ($110,000 times 5).

Cost Considerations

The cost of a group term policy is typically reasonable — especially for younger employees, because premiums are based primarily on age. Employers may even provide a stated amount of coverage free of charge with participants having the option to buy more coverage if they want it.

In addition, participants usually don't have to go through the lengthy underwriting process where the risks of the insured are assessed. This can be beneficial for those who have a history of health problems. Again, under an employer-provided group term plan, all eligible employees are covered — regardless of health status. However, underwriting may be required if an employee chooses to add life insurance protection.

Because group term life insurance is tied to employment, coverage automatically ends if a participant quits, retires or is fired for good cause. Some policies allow departing employees to convert their employer-provided coverage to an individual permanent life insurance. However, premiums may be significantly higher for this type of coverage.

Tax Angles

Under a long-standing tax code provision, an employer may provide an employee with up to $50,000 of group term life insurance coverage without any federal income tax consequences, but any excess is taxable. The taxable portion of this fringe benefit is reported on the employee's Form W-2. This amount, which is subject to payroll taxes as well as income tax, is based on IRS actuarial tables.

But the outcome often isn't as dire as it initially may sound. For instance, assume that a 50-year-old is entitled to $175,000 of group term life insurance. This policy is $125,000 over the IRS limit ($175,000 minus $50,000). Based on the IRS table, the employee's taxable income is only $345.

However, there's an important caveat: If the employer offers differing levels of coverage to a handful of employees — perhaps favoring some executives or key employees — the first $50,000 of coverage may be a taxable benefit to them. This carve-out feature applies to officers, highly compensated individuals and 5%-or-more business owners.

Bottom Line

Group term life insurance may be a good fringe benefit for your company. But consider all the potential ramifications before buying coverage — especially if you're thinking about a carve-out feature. Your professional advisors can help you make the right decision.

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