Life Insurance as an Employee
Benefit
What is it?
In general
Life insurance is a method of providing funds
payable to named beneficiaries upon the death of the insured. If you, the
employer, offer your employees life insurance as a benefit, it most likely will
be in the form of group life insurance. Group life insurance provides insurance
for a group of employees through a contract that exists between you and the
insurance company. Generally, group life insurance can be similar to the types
of life insurance policies that are available on an individual basis, such as
term, whole, and universal life. The actual group life insurance contract is
issued to you rather than to each individual employee, and the contract, known
as the master contract, provides coverage for the entire group. In lieu of
having the master contract in hand, the insurance company issues each employee
a certificate of insurance as proof of coverage. Although your employee is not
a party to the master contract, he or she will be able to enforce his or her
legal rights under the master contract as a third-party beneficiary.
Tip: By paying a portion of the premium of a
group life insurance policy, you can provide your employees with death benefit
coverage at minimal cost to the individual employee.
Tip: One of the major disadvantages of providing
your employees with certain types of group life insurance is that the policy
must comply with Section 79 of the Internal Revenue Code. All
employer-sponsored employee benefit plans must comply with applicable
nondiscriminatory requirements and rules. As an employer, you must comply with
certain nondiscrimination requirements.
Tip: A group life insurance plan qualifies as an
Employee Retirement Income Security Act (ERISA) welfare benefit plan and is
subject to the ERISA rules.
Tip: You can offer your employees the convenience
of payroll deductions for the employee's share of the premiums.
Tip: You can offer your employees a minimal
amount of life insurance (e.g., one to two times an employee's annual salary)
and allow employees to purchase optional amounts with low premiums.
Tip: Since group life insurance is a contract
between your company and the insurance company, you can terminate the plan at
any time.
Term versus
cash value life insurance
Generally, there are two types of insurance:
term and cash value. Term insurance provides protection only and does not
accumulate cash value that you can draw on in the future. As a result, term
insurance requires minimal cash outlay in the beginning and requires no
long-term commitments. On the other hand, if a life insurance policy
accumulates cash value, any excess funds that your employee pays toward the
permanent contract (the part of the premium that exceeds the cost of providing
the death benefit) build up equity in the policy. Cash value life insurance
provides your employees with protection besides building savings within the
policy for their future use. Cash value can be a useful tool for an employee
because it offers the opportunity to obtain a policy loan or the policy can be
surrendered for cash value at date of surrender.
Group term life insurance
In general
Group term life insurance is a contract
between your company and the insurance company that lasts for a specific period
of time and provides death benefits on the life of your employee.
Group term
life insurance carve-out plan
Under a group term life insurance carve-out
plan, you remove certain highly compensated employees from the group term life
insurance plan coverage and provide those employees with individual life
insurance policies. These individual policies can include split dollar; death
benefit only; or a Section 162 executive bonus plan.
Contributory
or noncontributory
Under a group term life insurance policy,
you, the employer, pay all or part of the premium. The amount of the premium
that you pay depends on whether or not the policy is contributory or
noncontributory. If a group term life insurance policy is contributory, you pay
the majority of the premium, while your employee pays a small portion of the
premium. If a policy is noncontributory, you pay the entire premium.
Group whole life insurance
In general
Under a group whole life insurance policy,
the employee pays a fixed premium for the duration of his or her lifetime
(ordinary life) or over a lesser period of time (limited pay life). While many
variations of the group whole life insurance policy exist, it is mainly a
mixture of both term and permanent insurance. Your employee's premium payment
usually goes to the permanent insurance portion, while your payment goes to the
term insurance portion. Group whole life insurance allows you to offer your
employees employer-paid term insurance with the additional coverage of a
permanent group life insurance plan.
Example(s): Bill works for XYZ Company,
which offers its employees a group whole life insurance policy. XYZ pays a
portion of the premium that purchases the term life insurance, while the
employee pays the premium for any permanent coverage. Bill can elect to receive
only the term life insurance, with the premium being paid completely by XYZ. In
addition, Bill can choose to have both term and permanent coverage; he will be
personally responsible for that portion of the premium that purchases the
permanent coverage.
Group universal life insurance
Under a group universal life insurance
policy, your employee has the flexibility to pay premiums within the range of
the minimum amount required to keep the policy in effect or the maximum amount
allowed by the policy (fully fund). The minimum premium is usually not enough
to accumulate a large amount of cash value. On the other hand, your employee
can choose to fully fund the policy. If your employee fully funds the policy,
he or she can cover the cost of keeping it in effect even while accumulating a
large amount of cash value over time. If the employee cannot afford to spend
much money on insurance premiums, he or she may want to pay the minimum
premium. An employee who wants to limit his or her payments during retirement
or to accumulate funds in the policy for future uses may want to pay more than
the minimum premium.
Split dollar life insurance
In general
A split dollar life insurance arrangement, or
SDA, is an agreement between you and your employee to share the costs and
benefits of the life insurance policy on the life of the employee. An SDA is an
agreement that concerns (at least in part) the premium payment (and eventual
repayment) for the life insurance; it is not a type of policy.
Split dollar arrangements usually take one of
two forms. In the endorsement form, the employer is formally designated as the
owner of the insurance contract and endorses the contract to specify the
portion of the insurance proceeds payable to the employee's beneficiary. In the
collateral assignment form, the employee is formally designated as the owner of
the contract, and the employer's premium advances are secured by a collateral
assignment of the policy.
Caution: The Sarbanes-Oxley Act of 2002 makes it a
criminal offense for a public company to lend money to its executives or
directors. This may prohibit the use of the collateral assignment form in these
companies.
Split dollar life insurance is an important
part of the compensation package of many key employees. In a typical split dollar
arrangement, the employer funds all or part of the cost of providing an
employee with life insurance protection and then recoups that cost either from
the cash value of the policy or from the death benefit. Split dollar
arrangements have also come into wide use in gift and estate planning.
Effective as of September 17, 2003 are two
mutually exclusive regimes for taxing split dollar life insurance arrangements:
the economic benefit regime and the loan regime. Both the owner and the
non-owner are required to fully and consistently account for all amounts under
a split dollar arrangement under either the economic benefit regime or the loan
regime.
Under the economic benefit regime, the owner
of the life insurance contract is treated as transferring economic benefits to
the non-owner. This regime generally governs the taxation of compensatory
arrangements in which the employee is not the owner of the contract (e.g.,
endorsement split dollar arrangements).
Under the loan regime, the non-owner is
treated as lending premium payments to the owner. The loan regime generally
governs the taxation of collateral assignment split dollar arrangements (e.g.,
arrangements in which the employee is designated as the owner of the contract
and the employer (non-owner) pays all or a portion of the premiums).
Key employee life insurance
Key employee life insurance is a life
insurance policy that insures the life of an employee whose death would cause
significant economic loss to a business. Under this kind of life insurance
policy, you purchase an insurance policy on the life of an employee. You become
both the owner and the beneficiary for the policy and are responsible for
paying the premiums. At your employee's death, the insurance company pays the
death benefits to you. The proceeds are received tax free.
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IMPORTANT DISCLOSURES
The
information presented here is not specific to any individual's personal
circumstances.
To the extent
that this material concerns tax matters, it is not intended or written to be
used, and cannot be used, by a taxpayer for the purpose of avoiding penalties
that may be imposed by law. Each taxpayer should seek independent advice from a
tax professional based on his or her individual circumstances.
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materials are provided for general information and educational purposes based
upon publicly available information from sources believed to be reliable—we
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