Taxation of Group Life Insurance

Key Points

-The value of employer-paid group term life insurance up to $50,000 is a tax-free benefit to the employee. The value of coverage in excess of the first $50,000 is treated as a taxable benefit to the covered employee. -Any after-tax contributions the employee makes toward the cost of his or her group life coverage is subtracted from the imputed income on a dollar-for-dollar basis. -While employee-paid group life premiums are not deductible by employees, the employer can deduct premiums it pays on a group life insurance plan.

Group Life Insurance Plan Ownership

Under an employer-sponsored group insurance plan, the employer owns the policy and holds the master policy (in a group life policy, the master policy indicates the sponsor as policy owner and premium payor.) The employees are the individual insureds whose coverage is evidenced by a certificate of coverage. The amount of insurance coverage provided for each employee is typically a percentage of his or her salary, such as 100 percent, 150 percent, 200 percent, etc. The employer often pays the entire premium. However, some plans may call for contributions by the employee.

Quiz

Question 1 Which statement about group insurance is NOT true? The employer owns the policy, holds the master policy, and often pays the entire premium. -Employee contributions are disallowed. The employees are the individual insureds. The amount of insurance coverage provided for each employee is typically some percentage of his or her salary. The employer may pay the entire premium. However, employees usually contribute to the premium. Question 2 What does the employer own under a group insurance plan? the employees' right to negotiate on their own behalf the right to charge what it wants for participating employees the value of the group insurance and the insurance contracts -the master policy The employer does own the master policy under a group plan. Question 3 Sally is a 25-year-old clerk employed by Acme, Inc. Under Acme's employer-pay-all group life plan, Sally's coverage is $60,000. The premiums for what portion of that coverage are taxable to Sally? -$10,000 $20,000 $30,000 $40,000 The cost of the first $50,000 of coverage is tax exempt for employees. Because Sally has $60,000 of coverage, $10,000 ($60,000 - $50,000) is taxable to her. Question 4 Which statement about death benefits paid to a beneficiary under a group life insurance plan is NOT correct? -They are fully tax exempt. If paid under a settlement option, interest on the payout is taxable to the beneficiary. Taxation of death benefits paid under a group plan is the same as that of individually owned policies. They are tax exempt if paid in a lump sum. The taxation of the death benefit paid under a group plan is the same as that of individually owned policies. Question 1 What part of group life insurance-if any-is tax exempt for employees? the cost of the first $100,000 of coverage $0 the cost of the first $25,000 of coverage the cost of the first $50,000 of coverage -The cost of the first $50,000 of coverage is tax exempt for employees. In other words, the premium charged for the first $50,000 of coverage is not taxable to the employee. But the cost of any amount over that level of coverage is taxable. Question 2 Any after-tax contributions Tom makes toward the cost of his group life coverage are treated in which of the following ways? They are added to his imputed income on a dollar-for-dollar basis. They are added to his taxable income. -They are subtracted from his imputed income on the employer's contributions on a dollar-for-dollar basis. They are subtracted from his taxable income. They are subtracted from, not added to, Tom's imputed income on a dollar-for-dollar basis. Question 3 The group term life insurance premiums an employer pays are fully tax deductible to the employer. Which of the following statements is true for a covered employee? the value of coverage under $70,000 is not taxable the value of coverage under $30,000 is not taxable -the value of coverage under $50,000 is not taxable the value of coverage over $30,000 is not taxable The group term life insurance premiums an employer pays are fully tax deductible to the employer. For a covered employee, the value of coverage under $50,000 is not taxable. Question 4 Which of the following statements best describes how employer-paid premiums for group life insurance are treated for tax purposes? Group life insurance premiums are tax deductible to the employer to the extent that they exceed the income of the lowest-paid plan participant. Group life insurance premiums are not tax deductible to the employer. Employers may only deduct premiums paid for rank-and-file participants in a group life insurance plan. -Employers can deduct premiums paid on a group life insurance plan. Group life insurance premiums are tax deductible to the employer.

IRC Section 79

The taxation of group term life insurance is covered by Section 79 of the Internal Revenue Code. Under this section, the value of employer-paid group term life insurance up to $50,000 is a tax-free benefit to the employee. The value of coverage in excess of the first $50,000 is treated as a taxable benefit to the covered employee, who must include the amount in his or her income for tax purposes. The value of the employer-paid group term life insurance in excess of $50,000 is determined under IRS Table I. IRS Table I defines the monthly "cost-per-$1,000" of group life coverage (see table below). These figures—not the actual premium costs the employer pays—are used to determine the value of the group life coverage for tax purposes. Consider the 46-year-old employee who has $120,000 in employer-funded group life coverage. The value of coverage for this employee is $.15 per month per $1,000 of coverage in excess of $50,000 (i.e., $70,000). Assuming the employee was covered a full year, the taxable value of coverage for this employee (called "imputed income") is $126, calculated as follows: ($.15 × 12 months) × 70. Age Monthly Cost Under 25 $.05 25 - 29 $.06 30 - 34 $.08 35 - 39 $.09 40 - 44 $.10 45 - 49 $.15 50 - 54 $.23 55 - 59 $.43 60 - 64 $.66 65 - 69 $1.27 70 and Older $2.06 Any after-tax contributions the employee makes toward the cost of his or her group life coverage is subtracted from the imputed income on a dollar-for-dollar basis, thus reducing the tax liability. As with individual life insurance, death benefits paid to the employee's beneficiary under a group life insurance plan are exempt from income taxes if they are paid in a lump sum. If they are paid under a settlement option, the interest portion of each periodic payment is taxable to the beneficiary. In these ways, the taxation of the death benefit paid under a group term life insurance plan is the same as that of individually owned policies.

Employer Deduction

While employee-paid group life premiums are not deductible by employees, the employer can deduct premiums it pays on a group life insurance plan. However, the plan cannot discriminate against rank-and-file employees. To ensure that this does not happen, the plan must meet specific requirements: -The plan must benefit at least 70 percent of all employees. or -At least 85 percent of the employees who participate in the plan must not be key employees.