Taxation of Group Life Insurance

Taxation of Group Life Insurance


While there are some similarities in the tax treatment of group life insurance and individual life insurance, there are also some notable differences.

Group Life Insurance Basics

Group life insurance is provided through a group insurance master policy owned by the group plan sponsor (e.g., employer, labor union, etc.).

The amount of life insurance coverage provided for each employee is typically a percentage of his or her salary, such as 100 percent, 150 percent, 200 percent, etc.

As with individual life insurance, death benefits paid to the employee's beneficiary under a group life plan are exempt from income taxes, though interest earned on funds retained by the insurer under a settlement option is taxable in the year earned.

Taxable Employee Benefit

As an employee benefit, employer-funded group life coverage may be taxable to covered participants. Per Section 79 of the Internal Revenue Code:

  • 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 $50,000 is a taxable benefit to the plan participant, who must include the amount in his or her income for tax purposes.

For tax purposes, the value of employer-paid group term life insurance in excess of $50,000 is determined under IRS Table I (below), which lists the monthly cost-per-$1,000 of group life coverage by age. These values—not the actual premium costs the employer pays—are used in determining the taxable value of the employer-funded group life coverage.

Because it is reported as income on plan participants’ Form W-2, this taxable value is called imputed income.

Age Monthly Cost per $1,000 of Coverage

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

IRS Table I, Uniform Premiums of Group Life Insurance Premiums

Employee Contributions Offset Imputed Income

Employee contributions are not tax deductible, though they can help reduce the tax impact of employer contributions. An employee’s after-tax contributions are subtracted from imputed income on a dollar-for-dollar basis, thus reducing the tax liability.

Note that this applies only to after-tax premium contributions (i.e., contributions deducted from the employee’s net “take-home pay”). Employee contributions paid using pre-tax contributions (e.g., as part of a cafeteria plan) cannot be used to offset imputed income.

Example

After-tax employee contributions to a group life insurance plan directly reduce the imputed income of the plan sponsor’s contributions, thus reducing the tax “hit.”

Consider the 53-year-old employee who has $175,000 in employer-sponsored group life coverage. The IRS Table I monthly cost for this employee is $.23 per $1,000 of coverage in excess of $50,000 (i.e., $125,000). The taxable imputed income for the year is $345 [i.e., ($.23 × 12 months) × 125].

If this were a noncontributory plan, the employee’s year-end W-2 would report $345 as income.

In this case, it is a contributory plan into which the employee contributes $25 per month ($300 annually). This amount is deducted from the imputed income, leaving a net amount of $45 reported on her W-2.

Employer Deduction

Although employees cannot deduct their group life insurance contributions, the employer can deduct its premiums as long as the plan does not discriminate against rank-and-file employees. To ensure that this does not happen, the plan must meet one of the following two requirements:

  • At least 70 percent of all employees must participate.
  • At least 85 percent of the plan participants must be rank-and-file employees.

For Your Review

  • 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, reported as imputed income.
  • Though employee contributions are not tax deductible, 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 as long as the plan is nondiscriminatory.