What Is a Group Carve-Out Plan?

A group carve-out plan is a type of group term life insurance designed to reward key employees beyond what is available to them through the company’s group term life insurance plan.

Key employees may include those with a long tenure with the company, executives, team leaders, or managers. Those deemed eligible have access to potentially significant life insurance benefits that may increase in cash value over time. 

Key Takeaways

  • A group carve-out plan rewards top-level employees with insurance benefits above the group term life insurance plan.
  • These added benefits can amount to large cash values over time that provide an incentive for key employees to remain with the firm.
  • A group carve-out plan involves keeping a portion of group term life insurance coverage with a universal life insurance policy providing the remaining amount for key employees.
  • A universal life policy makes the overall life insurance package more attractive in that it is portable and can create supplemental retirement income.
  • Group carve-out plans provide tax-benefits to employers.

How a Group Carve-Out Plan Works

As part of a group carve-out plan, the employee retains $50,000 of ordinary group term life insurance coverage while a universal life insurance policy provides the rest. The group carve-out plan replaces the current group life insurance amount over $50,000 on the individuals the company wishes to set aside or carve out.

Disadvantages of ordinary group term life insurance include its nondiscrimination requirement, loss or reduction when the employee decides to retire or leave the company (or high expense to continue it), and imputed income costs for coverage over $50,000.

The universal life policy improves the overall life insurance package in that it is portable and can create supplemental retirement income through its cash value. It is also not subject to nondiscrimination rules, allowing employers to offer it only to the employees they care most about retaining, such as top executives.

Benefits for an Employer

For employers, a group carve-out provides the benefit of better cost efficiency, including tax-related expenditures, than through a group term plan. The employer receives a current income tax deduction for the entire premium paid for the group term life insurance and the employee-owned universal life insurance policy. The group term life insurance premium is deductible as an employee benefit, and the employer-paid portion of the universal life insurance policy premium is deductible to the employer as compensation. 

Perhaps the greatest benefit to an employer, however, is the retention of key employees. It is always a risk for a company that the best performers will leave for another job, one that offers more money, better benefits, or other attractive elements that cause them to leave the firm.

Not only is the loss of top performers a cost to a company, but the additional cost of hiring and training new employees can be impactful to a firm as well, especially if the new hires aren't as good as the employees that left.

It is for this reason that employers try and retain important employees by offering them incentives to stay. A better insurance policy is one of those incentives that might be important enough to convince an employee to remain with the firm.

Incentivizing employees to stick with the firm is particularly important in times of economic downturns or when the company is financially struggling. It is often the top performers that will get the firm out of difficult times.

Example of a Group Carve-Out Plan

Before a carve-out, say an eligible key employee has $250,000 in group term life insurance coverage. Of that coverage, the federal government taxes anything above $50,000 as imputed income. In this example, the company would be taxed on $200,000, which could be a rather significant tax consequence for the company.

However, after the carve-out, the employee has $50,000 in group term coverage, which is capped at that level to avoid sustaining the imputed income and the associated tax penalties. The individual life insurance policy funded by the employer provides for the additional coverage, growing in cash value over time. This benefits both the employee and employer, helping to save money in taxes and administration while offering supplementation for retirement income.