In today's tight labor market, your organization may be searching for new and innovative ways to attract and retain employees. But one of the best benefits is hiding in plain sight: Group-term life insurance. It has been offered by employers to workers for decades and remains popular with both groups for good reason. It provides tax-favored coverage for rank-and-file workers, and you can carve out extra benefits for executives.
As its name implies, group-term insurance generally provides term life insurance protection for a group of employees. Because workers are insured as a group, the cost is generally less expensive than individual policies would be. Employers of primarily younger workers generally pay less than employers of primarily older workers.
If you decide to offer group-term life insurance coverage, it must be available to all eligible employees (for example, those who have worked a certain number of hours per week or been employed a specified length of time). Participating employees continue to be covered as long as they remain employed by your company. Coverage amounts can vary, but it's typically based on a multiple of an insured employee's salary (you can exclude other forms of compensation, such as bonuses and commissions from the calculation). If, for example, an employee has a salary of $50,000 a year and the applicable multiple is three, coverage is extended for a death benefit of $150,000.
Generally, employers provide a stated amount of coverage free of charge. Then they enable employees to purchase additional coverage if they wish. Group participants usually don't have to go through the lengthy underwriting process. This can be beneficial for those who have a history of health problems. With an employer-provided group-term plan, all eligible employees are covered — regardless of their health status. But underwriting may be required if an employee opts for additional protection.
Because group-term coverage is tied to employment, coverage automatically ends if an employee quits, retires or is fired for cause. Some policies permit a departing employee to convert to an individual permanent life insurance policy. However, the premiums of such policies can be significantly higher.
For employers, the tax implications of group-term life insurance can be significant. Under a long-standing tax code provision, an employer may provide an employee with up to $50,000 of group-term coverage without any federal income tax repercussions. But any excess is taxable. The taxable portion of this fringe benefit must be reported on the employee's annual Form W-2 and is subject to payroll and income taxes. The taxable amount is calculated based on the employee's age.
Note a caveat: If you offer differing levels of coverage to employees — perhaps giving higher benefit levels to executives — the first $50,000 of coverage may be a taxable benefit to them. This rule applies to officers, highly compensated individuals (HCEs) and 5%-or-more business owners.
If you want to "sweeten the pot" for select key employees, you can use a "carve-out plan." With this arrangement, all eligible employees receive $50,000 of tax-free group-term life insurance. But the plan also provides permanent life insurance (such as universal life) above the $50,000 threshold to the select group of employees.
This permanent life insurance isn't subject to the regular nondiscrimination rules and is portable — meaning employees can take the benefit with them when they separate from your company. Another advantage that can help attract and retain talent is that permanent coverage can build up a cash value that employees may be able to tap as retirement income. What's more, a carve-out plan can be structured so that employees pay less income tax on the employer-provided permanent coverage than would be owed on the same amount of group-term coverage.
Carve-out plans can work to the advantage of employers, too. Premiums paid for group-term life insurance currently are tax-deductible as a fringe benefit. Depending on your plan's structure, the employer-paid portion of the permanent insurance policy is also deductible as employee compensation.
Carve-out plans do have potential drawbacks. Depending on the structure of your plan, you may not be able to deduct premiums that pay for the permanent insurance coverage. And, of course, there's no guarantee that permanent life insurance will lure the executives you hope to hire or retain. You may find after you've set up a carve-out plan that your target employees prefer other fringe benefits.
Before offering group-term life insurance or a carve-out option, consider all the potential ramifications, including the ongoing cost of offering these benefits. Talk to your financial advisor and an insurance expert to ensure you select the best coverage at the most reasonable cost.
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