Carving out life insurance benefits for employees
Traditionally, group-term life insurance coverage is a popular fringe benefit for
employees. For example, each employee may be covered for three or four times his
or her annual salary. The company may foot the entire bill or require employees to
kick in contributions. Either way, since the cost is determined by group rates,
the premiums are generally quite reasonable.
Basic Tax Benefit: Assuming the plan is properly structured, the first $50,000 of
coverage is tax-free to an employee. However, the value of any excess coverage is subject
to federal income tax. The amount of taxable income is figured under a special government
table.
The older you are, the higher the value for income tax purposes.
Hypothetical Example: Ebenezer Smith and Florence Jones, the two principals of
Eb & Flo, Inc., are 45 years old and 55 years old, respectively. Each one receives
$300,000 of group-term insurance coverage from the company plan and neither contributes
to the cost. Result: the excess coverage above $50,000 results in annual income of $450
to Smith and $1,290 to Jones.
The taxable amount increase even more drastically for older employees. For example,
a 65-year-old who receives $300,000 of coverage would be charged with taxable income
of $3,810. Note: these amounts are reduced by employee contributions to the cost
of coverage.
Other Factors: Aside from the tax cost of group-term life insurance, another
consideration is that coverage may be lost when an employee retires or quits. And,
of course, group-term coverage provides death benefits only. It has no cash value.
Accordingly, some employees would be better served by a policy with permanent cash-value
life insurance protection. In addition, employees could take advantage of a growing
cash equity. The funds may be tapped for college costs, buying a home, starting a
business or some other worthwhile purpose.
In view of this, some companies are converting their group-term plans to group carve-out
plans. How It Works: The funds that go toward group-term coverage in excess of
$50,000 are "carved out" and paid to employees as bonuses or credits. The employees use
these bonuses or credits to buy permanent life insurance.
Result: Besides the benefits already indicated, employees are able to maintain
their permanent insurance after retirement. Furthermore, since group-term coverage is
limited to $50,000, there is no additional taxable income. Of course, employees are
taxed on the bonuses or credits.
A group plan can make it easier for a company to attract and retain valuable
employees at a relatively low cost. With the proper planning, your company con
adopt the type of plan that best fits its needs.