Life Insurance as an Employee Benefit

Life insurance is a contract whereby the insurance company pays a sum specified within the contract to a named beneficiary upon the death of the insured, in exchange for the payment of an agreed upon premium . If your employer offers life insurance as an employee benefit, it most likely will be in the form of group life insurance. Group life insurance provides insurance for a group of employees through a contract that exists between an employer and an insurance company. The actual group life insurance is usually issued to the employer rather than to each individual employee. This contract is known as the master contract and provides coverage for the entire group. In lieu of having the actual contract in hand, the insurance company will issue each employee a certificate of insurance as proof of coverage. Although you as an employee are not a party to the master contract, you still are able to enforce your legal rights under the master contract as a third party beneficiary.

Generally, group life insurance mirrors the types of life insurance policies that are available on an individual basis, such as term, whole, and universal. If a group life insurance policy is permanent, it accumulates cash value . In other words, any excess funds that you pay towards the permanent contract (the part of the premium that exceeds the cost of providing the death benefit) builds up equity in the policy. Cash value life insurance provides protection, in addition to accumulating cash within the policy for your future use. Cash value can be a useful tool for the individual policyholder because it offers the opportunity to obtain a policy loan or to surrender the policy. If a group life insurance policy is a term one, it provides protection as long as the premium is paid. A term policy does not accumulate cash value that you can draw upon in the future. While term insurance does not accumulate cash value, it requires minimal cash outlay in the beginning and does not require a long-term commitment.

Some companies will provide insurance to their employees by making payroll deductions to any insurer. Many companies will offer employees insurance at no cost (e.g., one to two times an employee's annual salary), and allow employees to purchase additional insurance with low premiums.

In addition to the obvious advantage of providing your beneficiaries with funds upon your death, a group life insurance policy can offer many additional advantages. Typically, the cost you incur funding a group life insurance policy must be included in your gross income. However, there are certain limited exceptions (e.g., the first $50,000 of group term life insurance), although it is rare that these exceptions apply to the average employee. In addition to its possible tax benefits, group life insurance usually does not require medical underwriting. Individual life insurance policies generally require the insurance company to evaluate your health in order to prove to the company that you are insurable. If you are in poor health, it is likely that an individual policy may require you to pay high premiums or that the company may not find you insurable. With a group life insurance policy, the insurance company does not perform medical underwriting on an individual basis. Instead, you may be asked a series of simple medical questions while the characteristics of the group as a whole (e.g., size, stability, and group makeup) are evaluated.

Group term life insurance

Group term life insurance is a contract between an employer and an insurance company that lasts for a specific period of time (usually until you retire, reach a certain age, or leave the company) and provides death benefits upon your death. Term life insurance plan provides only term coverage, it does not accumulate any cash value. Since you may only have to pay a small portion of the premium for a group term life insurance policy, group term life insurance can be a low-cost method of providing your beneficiaries with death benefits.

Group life insurance carve-out plan

Under a group life insurance carve-out plan, your employer removes certain highly compensated employees from the group term life insurance plan coverage and provides those employees that were "carved-out" with individual life insurance policies. One of the major disadvantages of a carve-out plan is that because it is an individually based plan, it is likely to require you to be individually underwritten. If you have health problems, you should be aware that you may have a heavy policy rating or be deemed uninsurable under an individual plan.

Contributory or noncontributory

Under a group term life insurance policy, your employer usually pays for a base amount while you pay for any supplemental amounts. The amount of the premium that your employer pays depends on whether the policy is contributory or noncontributory. If a group term life insurance policy is contributory, your employer pays the majority of the premium, while you pay a small portion of the premium. If a policy is noncontributory, your employer pays the entire premium.

Beneficiary designation

You are free to name any person or persons who you want to receive the proceeds of your group term life insurance policy upon your death. In addition, you can name your beneficiary on either a revocable or irrevocable basis.

Death benefit coverage

Generally, the amount of death benefit coverage you have under a group term life insurance policy is determined by using a benefit schedule. However, some plans may place a ceiling on the amount of coverage that the policy provides.

Example 1: Diane earns an annual salary of $40,000. Diane's group term life insurance policy provides death benefit coverage in an amount that is equal to twice her annual salary, or 2 x $40,000 = $80,000.

Example 2: Bonnie earns an annual salary of $75,000. Her group term life insurance policy provides death benefit coverage in an amount that is equal to twice her annual salary, with a $120,000 limitation on the coverage amount. As a result, Mary would not receive $150,000 (or 2 x $75,000) worth of coverage, but a death benefit of $120,000. In addition to being based on your annual salary, death benefit coverage can be a set amount (e.g., $50,000) for all employees.

Tax treatment of group term life insurance

As long as your group term life insurance plan meets certain requirements, you can exclude the cost of the first $50,000 of insurance from your gross income provided it meets the requirements of IRC Section 79. The cost of any amount over the $50,000 limit must be included in your gross income, unless you pay for the coverage with after-tax dollars. (The amount over $50,000 that is included in your gross income is known as imputed income.)

Generally, the cost of employer-provided group term life insurance that exceeds $50,000 is taxable to you. If you fall within an exception, the cost of group term life insurance that exceeds $50,000 is not included in your gross income. Group term life insurance costs that exceed $50,000 are not taxable to:

• Retired employees who fall within a special grandfather rule
• Employees who have terminated employment because of disability
• Employees whose beneficiary under the policy is their employer (either directly or indirectly), or
• Employees whose beneficiary under the policy is a charitable organization

The cost of group term life insurance on the life of your spouse or dependent (also known as employer-provided dependent group term life insurance) is included in your gross income. However, the cost is not included in your gross income if you pay for it on an after-tax basis. In addition, the cost of dependent group term life insurance can be excluded from your gross income as a de minimis fringe benefit if the face value of the insurance payable on either your spouse's or dependent's death is limited to under $2,000.

In order for an individual to be able to exclude death benefits (any amount that he or she receives from a life insurance policy as a result of your death) from his or her gross income, the individual must be a beneficiary and the amounts paid must be by reason of the death of the insured.

Group whole life insurance

Under group whole life insurance, you pay a fixed premium either over your lifetime (ordinary life) or over a shorter period of time (limited pay life). While many variations of the group whole life insurance policy exist, it is mainly a mixture of both term and permanent insurance. Your premium payment usually goes to the permanent insurance portion, while your employer's payment goes to the term insurance portion. Group whole life insurance allows your employer to offer employees employer-paid term insurance with the additional coverage of a permanent group life insurance plan. Since group whole life insurance is a permanent type of life insurance, it accumulates a cash value. The cash value of most group whole life insurance policies grows at a set rate. However, if a group whole life insurance policy is interest sensitive, the cash value grows at an interest rate that is subject to change. In addition, if a group whole life insurance policy is current assumption whole life , the interest rate, policy premium, and death benefit that are credited to the cash value of the policy may vary. When you retire, you can choose to either surrender the policy or continue your coverage by paying the premiums yourself.

Example 1: Bill works for Sample Company. Sample Co. offers its employees a group whole life insurance policy. Sample Co. pays a portion of the premium that purchases the term life insurance, while the employee pays the premium for any permanent coverage. Bill can elect to receive only the term life insurance and have the premium paid completely by Sample Co. In addition, Bill can choose to have both term and permanent coverage. In this case, he will be personally responsible for that portion of the premium that purchases the permanent coverage.

Dividend options

If a whole life insurance policy is "participating," it allows you to receive annual dividends. Usually, a participating whole life insurance policy offers a variety of dividend options from which to choose, such as buying paid up additions, reducing the policy's premium, accumulating at interest, buying additional term life insurance, or refunding the excess premiums as cash. If you use dividends to buy paid up additions, the insurance company uses each dividend to purchase you an additional amount of life insurance that does not require premium payments. If you use dividends to reduce the policy's premium, you pay a lower premium, but the death benefit of the policy will remain the same. If the insurance company pays the dividend to you in cash, the policy premium and the death benefit remain the same. If you choose to let the dividends accumulate at interest, the dividends stay with the insurance company, which pays a set rate of interest on the dividends. Finally, if you choose to buy additional term life insurance with your policy dividends, the insurance company will purchase term life insurance on your behalf.

Nonforfeiture options

If you are unable to pay your group whole life policy premium, you have two options: surrender the policy for cash value or exercise a nonforfeiture option. While you can surrender your group whole life insurance policy for its cash value at any time, if you surrender the policy, any death benefit coverage that you had under the policy terminates immediately. If you choose to exercise a nonforfeiture option, some of your death benefit coverage will remain, either for a shorter period of time or a lesser amount of coverage.

Generally, nonforfeiture options come in two forms: paid up term life insurance and reduced paid up whole life insurance. If you choose the paid up term life insurance nonforfeiture option, your premium payments end and you are left with a term policy that provides a certain amount of death benefit coverage for a specific period of time. If you choose the reduced paid up whole life nonforfeiture option, you use the cash value of the policy to purchase life insurance on a paid up basis.

Unless a policy has been held for many years, you may receive only a percentage of a policy's cash value upon surrender. An insurance company may seek reimbursement for unrecovered costs by issuing surrender charges on a policy's existing cash value. In today's job market, employees tend to move from job to job before surrender charges disappear.

Example 1: Ben wants to end his premium payments for his whole life insurance policy. However, Ben has a child for whom he still wants to provide death benefit coverage. Ben can exercise the paid up term nonforfeiture option that can end his premium payments, but still offer death benefit coverage for his child.

Group universal life insurance

Under a group universal life insurance policy, you can choose to either pay a minimum premium or fully fund the policy. By paying the minimum premium, you cover the cost of keeping the policy in effect. However, the minimum premium is usually not enough to accumulate a large amount of cash value. On the other hand, you can choose to fully fund the policy. If you fully fund the policy, you can cover the cost of keeping the policy in effect, while at the same time, accumulating a large amount of cash value. Minimum premium payments may be a good idea for an individual who cannot afford to spend a lot of money on insurance premiums. Fully funding a plan is a useful tool for the employee who wants to limit his or her premium payments during retirement, or to accumulate funds in the policy for use at a later date.

Unlike group term life insurance, group universal life insurance is not governed by Section 79 of the Internal Revenue Code. Group universal life insurance is taxed the same as if you purchased a universal life insurance policy on an individual basis. As a result, you cannot deduct premiums that you pay from your gross income. The interest rate that is credited to your universal life insurance policy's cash value is subject to change by the insurance company.

Selection of amount of death benefit coverage

In addition to choosing the type of premium payment, group universal life insurance allows you to choose the amount of death benefit coverage for your policy. Most policies will offer you a few choices, usually an amount that is equal to one-half, one, or two times your annual salary. The policy will normally impose a minimum death benefit level so that, even if one-half of your salary is less than the minimum amount, you must choose the minimum amount in order to participate. The amount of death benefit coverage provided under a group universal life insurance policy can be either increased or decreased, depending on your individual needs.

Example 1: ABCompany offers its employees a group universal life insurance plan. The plan offers a few choices for the amount of death benefit coverage you can have. These choices include one or two times your annual salary. In addition, the policy has minimum death benefit coverage of $15,000. Jack earns an annual salary of $60,000 and chooses the death benefit equal to two times his salary for a total of $120,000 in death benefit protection. Diane earns an annual salary of $28,000 and chooses the death benefit equal to one-half her salary or $14,000. Because the ABCompany policy has a minimum death benefit selection of $15,000, and because one-half of Diane's salary is less than the minimum amount required, Mary's death benefit coverage would be $15,000. Usually, a universal life insurance policy will offer a choice between two benefit options: Option A and Option B. Option A provides a death benefit coverage that remains constant.

Example 2: Anne's coverage under a universal life insurance policy begins at age 35. She chooses an Option A death benefit coverage of $100,000. Twenty years later, when Anne is 55 years old, the death benefit coverage of her policy will still be $100,000. An Option B death benefit coverage does not remain constant. Instead, it increases over time in proportion to the increases in the policy's cash value. The death benefit coverage under Option B is equal to the policy's face value plus the policy's cash value.

Example 3: Ben has a universal life insurance policy with death benefit coverage of $100,000. After five years of coverage, Ben's policy has accumulated $5,000 of cash value. If he chooses death benefit coverage Option B, his policy's death benefit coverage in year five will be $105,000.

Split dollar life insurance

Under a split dollar life insurance plan, both you and your employer share the costs and the benefits of the policy. Traditionally, your employer pays the part of the annual premium that is equal to the increase in the policy's cash surrender value . In turn, you pay the balance, if any, of the premium. When you die, your employer receives an amount equal to the cash surrender value, with the balance of the proceeds payable to a named beneficiary. While the life insurance death benefits of a split dollar life insurance policy are not taxable to your beneficiary, you may be required to include the value of the benefits you receive from the policy in your gross income.

While you must pay a large part of the first premium of a split dollar life insurance plan, your share of the premium decreases after the first year. As a result, you gain valuable life insurance protection with minimal premium payments in the beginning, and virtually no cost toward the end. There are two types of split dollar life insurance policies: the endorsement system and the collateral assignment system.

The endorsement method

Under the endorsement method of split dollar life insurance, your employer owns the policy and is responsible for annual premium payments. You are then required to reimburse your employer for your share of the premiums.

The collateral assignment method

Under the collateral assignment method of split dollar life insurance, you own the policy, pay the entire premium, and assign the policy to your employer as collateral for a loan (the employer portion of the premium). Your employer provides the loans at minimal or low interest for amounts that are equal to the yearly increases in the policy's cash surrender value, not exceeding annual premiums. The loans are usually payable at either the termination of your employment, upon your death, when the policy ends, or when the policy matures.

Reverse split dollar life insurance

Reverse split dollar life insurance is similar to traditional split dollar life insurance in that both you and your employer share the premium payments. However, unlike a traditional split dollar policy, you own the policy cash values of a reverse split dollar policy. Upon your death, your beneficiary receives the policy's cash value, and your employer receives the balance of the insurance proceeds (death benefit). Under a reverse split dollar arrangement, you do not include the cost of the premiums paid by your employer in income and the premiums you pay are nondeductible.

Key employee life insurance

Key employee life insurance is a life insurance policy that insures the life of an employee whose death would cause significant economic loss to a business. Under a key employee life insurance policy, your employer takes out an insurance policy on your life. Your employer becomes both the owner and the beneficiary of the policy and is responsible for paying the premiums. Upon your death, the insurance company pays the death benefits to your employer's business. The proceeds are not included in your employer's income.