Income Tax Implications of Group Life Insurance

  • The employer may deduct the premia that it pays for its employees so long as the employer complies with certain requirements detailed below. These come down to not discriminating in favor of key employees. Failure to comply would cause the initial $50,000 of life coverage to be included in a key employee's gross income.
    • Eligibility: the plan must benefit at least seventy percent of all employees or at least eighty five percent of all participating employees must not be key employees.
    • Benefits: the plan may not discriminate in favor of key employees. Life insurance coverage must bear a uniform relationship to an employee's level of compensation or their position within the company.
  • Employees need only report employer-paid premia to the extent that it pays for coverage in excess of $50,000.
  • Life insurance proceeds paid to a deceased employee's beneficiary.
    • Lump sum payments are income tax exempt.
    • Installment payments consist of principal and interest. The interest portion would be taxed.

Conversion to Individual Plan
  • State law determines whether a group plan must contain a conversion provision which allows the former employee to convert the group coverage to an individual policy without having to provide evidence of insurability. Where such a feature is permitted, the employee has thirty one days to convert to individual coverage. Group coverage would continue to be offered during that conversion period, irrespective of the employee's decision to convert.
  • The target plan (to which the employee converts) typically must be a whole life, rather than term, coverage. The premium for the new policy is based upon the former employee's attained age. Some employers allow the former employee to take portable group term coverage, essentially the same group coverage and rates.
Analysis and Application
While employees may have little say in the group coverage available to them, they need to be aware of existence of any portability features if and when they separate from service. It is the planner's role to help them at this critical juncture.

Conclusion
Group life insurance is a cost effective, tax advantaged method of enabling individual employees to obtain life insurance coverage and for many of them the only way to do so. Underwriting is simplified, benefits are less expensive and eligibility requirements are streamlined. Underlying coverage is typically annual renewable term, but whole life and universal life are also available. Depending upon state law, group life benefits may well be portable or convertible into individual coverage.
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