Employee Tax Implications when Group Life Insurance Policy Benefits are Paid

An employee does not have to report any income with respect to the premium paid for the first $50,000 of life insurance coverage provided by the group plan. Although term insurance protection provided by an employer to an employee is income tax-free for amounts of insurance up to $50,000, an employee must report and pay income tax on the economic benefit (i.e., the term insurance cost) of coverage in excess of $50,000.

The amount reportable is computed by multiplying the Table I rates shown by the amount of coverage in excess of $50,000. To determine the total annual economic benefit received and reportable by the employee, one must add these monthly rates/amounts together for each month of the year in which the employee is covered.

For purposes of Table I, the age of the employee is the employee’s attained age on the last day of the employee’s taxable year.

In the case of a contributory plan (i.e., the employee pays a portion of each month’s premium), the employee may reduce the reportable amount by the amount the employee has paid.

The steps in the computation process are:

  1. Find the total amount of group term life insurance coverage in each calendar month of the taxable year. (If the employee was covered with different amounts of group term life during the coverage period, average the amount payable at the beginning and the end of the period to find the proceeds payable.)
  2. Subtract $50,000 from each month’s coverage.
  3. Apply the appropriate rate from Table I.
  4. From the sum of the monthly costs, subtract total employee contributions for the year. (The employee’s contributions can be allocated entirely to the cost of the excess coverage over $50,000 to reduce or eliminate current tax cost to the employee. However, any unused portion of the employee’s contributions may not be carried over into later years.)

Example. Your client is age fifty-six, and her employer provides her with $150,000 of group term life insurance. She makes no contribution to the coverage. The excess amount over $50,000 is $100,000. The monthly rate, $0.43 per $1,000, is multiplied by 100 (000) to arrive at $43 per month. If she was covered for twelve months, the yearly income reportable by her would be $516. Had she made a contribution of $200, her taxable economic benefit would be reduced to $316.

It is obvious that Table I costs will increase dramatically once the client reaches his early sixties. Group coverage at retirement, if it is still available, becomes extremely expensive in terms of reportable income. This problem is particularly acute with respect to shareholder-employees with group life insurance significantly in excess of $50,000.

The economic benefit generated by coverage in excess of $50,000 will not be taxed to the employee to the extent:

  • the employer is the beneficiary;
  • a qualified charity is the sole beneficiary for the entire period for which the cost otherwise would be taxed to the employee; or
  • the employee has terminated employment with the employer because of disability.

None of the $50,000 exclusion is available for group term insurance provided through a Code section 401(a) qualified retirement plan, such as a pension, profit sharing, stock bonus, or qualified annuity plan. Generally, this means the employer premium for the entire amount of protection afforded with employer contributions is taxable to the covered employee. Table I rates may not be used.

The amounts reportable as income by the employee are also treated as additional salary for purposes of FICA and FUTA. State unemployment and workers’ compensation taxes may also apply in some states.

A beneficiary of group life insurance receives the death benefit income tax-free.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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