What Is a Group Carve-Out Plan?

A group carve-out plan is a type of life insurance benefit employers can use to reward key employees beyond what is available to them through the company’s group term life insurance policy. Key employees may include those with a long tenure at the company, executives, team leaders, or top salespeople. Those deemed eligible for the carve-out plan gain access to permanent life insurance, which can accumulate cash value over time. 

Key Takeaways

  • A group carve-out plan rewards certain employees with insurance benefits unavailable through the company's basic group term life insurance plan.
  • Those eligible for the carve-out receive $50,000 in tax-free term insurance, plus a permanent life policy that can accumulate cash value over time.
  • Companies use group carve-out plans as a way to retain their key employees.

How a Group Carve-Out Plan Works

As part of a group carve-out plan, the employee receives $50,000 of ordinary group term life insurance coverage, plus an individual permanent life policy, such as universal life, to provide additional coverage. The group carve-out plan replaces the current group life insurance amount over $50,000 for the individuals the company wishes to set "carve out."

The reason for the first $50,000 being ordinary group term coverage is that $50,000 is the maximum amount that is considered a tax-free benefit to the employee. Above that amount, the employee will have to pay income tax on the cost of any additional coverage provided by their employer, using an IRS formula based on their age.

Ordinary group term life insurance has some additional drawbacks. For one, it is subject to nondiscrimination rules, which require that all employees be eligible for the same benefits. It also lacks portability; coverage typically ends or is significantly reduced when the employee decides to retire or leave the company.

A universal life or other permanent policy, however, can be portable. It is also not subject to nondiscrimination rules, so employers can offer it only to certain employees of their choosing. And unlike term insurance, it can accumulate cash value, which the employee can later use to supplement their retirement income.

A carve-out can also be structured in such a way that the employee will pay less income tax on their employer-provided permanent coverage than they would have had to pay for the same amount of group term insurance.

Benefits for an Employer

In a carve-out plan, the employer receives a current tax deduction for the premiums it pays for the group term life insurance and, in some cases, for the employee's individual insurance policy. The group term life insurance premium is deductible as an employee benefit, and the employer-paid portion of the individual policy premium can be deductible by 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 its best performers will leave for another job, one that offers more money, better benefits, or other attractions. One way to single out and reward top performers, and try to retain them, is through a more lucrative insurance and retirement package.

Limitations of a Group Carve-Out Plan

Group carve-out plans are designed to overcome some of the major limitations of group term life insurance. However, they can also have some limitations of their own. For example, depending on how a plan is designed, employers may not be able to deduct the premiums they pay for the permanent insurance. What's more, there is no guarantee that the carve-out plan will serve the purpose of retaining valuable employees—especially if they find themselves being recruited by a company with an even better carve-out plan.