Group Term Life Insurance: A Compliance Primer

 

What Is Group Term Life Insurance?

Group term life insurance is defined as life insurance that satisfies the following conditions:

1. It provides a general death benefit that is excludible from income under Code §101(a). To be excludible under §101(a), there must be a binding, substantive arrangement, with a definite benefit, that is payable by reason of the death of the insured, and the arrangement must provide for shifting and distributing risk;

2. It is provided to a group of employees. The general rule is that a "group" of employees must include at least ten full-time employees (with some exceptions);

3. Coverage is provided under an insurance policy carried directly or indirectly by the employer. Even voluntary programs can be considered carried by the employer if certain conditions are met; and

4. The amount of insurance provided to each employee must be computed under a formula that precludes individual selection of such amounts. This condition is satisfied if the coverage is either a flat dollar amount or a specific percentage of an employee's compensation.

Under Code 79, an employee may exclude the cost of up to $50,000 of employer-provided group term life insurance from income. The exclusion applies only to insurance on the life of the employee {not the lives of spouses or dependents). If an employee receives more than $50,000 of employer-provided group term life insurance, then the cost of the insurance in excess of $50,000 {minus any amounts paid post-tax by the employee) is included in the employee's gross income. This is referred to as "imputed income."

For purposes of determining the employee's tax liability, an employee uses the total coverage amount from all employers. Employers can ignore coverage provided through another employer for purposes of imputing income. Therefore, if Employee Ann has $50,000 of coverage from Employer A and another $50,000 from Employer B, the total tax liability to Ann would be $50,000 {$100,000 total minus the $50,000 exclusion). Since neither employer exceeded the $50,000 exclusion, however, they would not have to impute income on the coverage.

The cost of coverage for determining imputed income is based on uniform rates set forth in Treasury Regulation §1.79-3, reproduced here:

Imputed income is calculated on a monthly basis on the benefit amount that exceeds $50,000 multiplied by the Table 1 rate that corresponds to the employee's age. After the Table 1 cost of the excess coverage is determined, the employee's taxable amount is reduced by any amount that the employee paid toward the coverage on a post-tax basis.

Example 1: Employer provides $100,000 of group term life coverage and pays 100% of the premium. There is $50,000 of excess coverage. To calculate a 40-year-old employee's imputed income, multiply 50 (the number of $1,000 units) by $0.10 (the rate from Table 1 for a 40-year-old). The imputed income is $60.00 for the year (50 x .10 = 5/month. 5 x 12 months of coverage = $60).

Example 2: Same facts as above except the employee contributes $3/month toward the premium with after-tax dollars. There is $50,000 of excess coverage. Do the same calculations as in Example 1, then subtract the employee's after-tax contributions ($3/month x 12 = $36). The imputed income is $24 ($60 minus $36).

These examples assume the program is non-discriminatory. Discriminatory plans lose their favorable tax treatment with respect to key employees (discussed below).

Voluntary Coverage
In some cases, employer-provided voluntary coverage is considered group term life, and needs to be added to other coverage when calculating imputed income. Voluntary coverage, even coverage that is 100% employee-paid, can be deemed to be "carried" by an employer when the employer arranges for payment of the premiums, and the premium rates "straddle the table." Rates straddle the table if at least one employee's cost is lower than Table 1 rates and at least one employee's cost is higher. This is viewed as some employees essentially subsidizing the cost of coverage for other employees, and the coverage is treated as group term life coverage that is subject to Code 79 rules.

Employers can avoid this by making sure employee-paid coverage is provided under a separate policy, is paid on a post-tax basis (e.g., not through a cafeteria plan) and that rates do not straddle the table.

Non-Discrimination Rules
Group term life plans are subject to non-discrimination provisions. In general, if employer provided group term life coverage is discriminatory under Code 79, "key" employees lose the exclusion from income that would otherwise apply for the first $50,000 of coverage. The key employees' coverage would be taxed at either the greater of Table 1 value or the actual cost.

Key employees are:

  • Officers of the employer with annual compensation in excess of a specified dollar threshold
    ($170,000 for 2016);
  • A more-than-5% owner of the employer; or
  • A more-than-1 % owner of the employer with annual compensation in excess of a specified
    dollar threshold ($150,000 not indexed).

Discrimination testing has two components: Eligibility testing and benefits testing.

Eligibility test: A plan is discriminatory if it favors key employees with respect to eligibility to participate. Code 79 provides 4 alternative ways to pass the eligibility test:

1. The plan benefits 70 percent or more of all employees of the employer;

2. At least 85 percent of all employees who are participants under the plan are not key employees;

3. The plan benefits a class of employees on a non-discriminatory basis (non-discriminatory classification test); or

4. For plans offered through a cafeteria plan, the Code §125 non-discrimination requirements are satisfied.

Benefits test: A plan is discriminatory if the type and amount of benefits available under the plan favor key employees. There are two safe harbors to pass the benefits test:

1. The percentage of compensation or fixed amount safe harbor. If the amount of life insurance has a uniform relationship to employees' total compensation or to their basic or regular compensation it passes the test; or if all covered employees receive the same fixed amount of coverage it passes the test.

2. The rate group safe harbor. This allows the employer to apply the eligibility test to each group of employees that is made up of a key employee and all other participants (including other key employees) that receive coverage greater than or equal to the key's coverage as a percentage of compensation.

If a plan doesn't meet either safe harbor, then the determination about whether the plan is discriminatory is made on a facts and circumstances basis.

For additional information, please reference IRS Publication 15-B, "Employer's Tax Guide to Fringe Benefits" or contact your Alliant service team member.

Updated October 2018

The information contained in this document is neither intended nor implied to be legal or regulatory advice or counsel. It is provided for general informational purposes only and represents a summary based on publicly available sources. We make no representations about and assume no responsibility for the accuracy or completeness of information contained in this document and such information is subject to change without notice.

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