Across the country, employers are looking for ways to provide life insurance for their valuable employees. From the largest corporation to the smallest local business, employee insurance policies represent a benefit or “perk” of employment at a given business. That solution may be a group carve-out plan, says Geoff Thompson of Synergistic Life Services.
The difficulty arises in the costs associated with providing life insurance policies for employees. An available option is group term life insurance, which can be an excellent way for businesses – even small businesses — to create full and surprisingly affordable life insurance policies for employees. In this article series, we will discuss group term life insurance, including the advantages and disadvantages, of these plans.
Group Term Life Insurance – What Is It?
In simple terms, group term life insurance is a type of insurance policy provided to a group, such as the employees of a company, organization, or association. Coverage under the group term plan includes a benefit paid to beneficiaries if a person covered under the plan should die. The “term” in group term means that there is a period of coverage; typically that coverage under the plan applies as long as the employer makes premium payments on the plan and the employee continues to work for the company providing the group term insurance benefit.
Group Term Life Insurance Advantages and Disadvantages
As with any employer/employee benefit or as an investment to protect financial stability, there are strengths and weaknesses in group term life insurance plans. Advantages include:
- Group term insurance is relatively inexpensive to provide to employees of a company.
- Plans are generally easy to administer, even by the smallest company.
- As employee salary increases, the amount of coverage under the plan also increases (a nice employee benefit rewarding longevity).
- The company providing group term insurance to its employees may deduct costs associated with the plans from annual taxes.
Disadvantages are few, but some are rather significant. These disadvantages include:
- Plans are one-size-fits-all-employees. In other words, there is no way to enhance benefits under a group term plan for key employees such as team leaders and managers.
- Plans do not build up cash value, unlike other employer benefit plans and insurance policy types.
- As the average age of employees covered under the plan increases, the costs can also increase, sometimes dramatically.
- If coverage exceeds $50,000, the benefit is considered imputed income, or the value of a benefit provided to employees, and is taxable just as regular income is.
It is this last disadvantage that is the most critical. For specific employees, such as those in leadership positions or who have been with the company for many years and have over $50,000 in coverage under a group term plan, this disadvantage tends to negate any benefits of such a plan. A key employee can pay substantial taxes on these benefits, and of course, there is no cash value accruing, no matter how long the plan is in effect.
A Solution: The Group Carve-Out
Employers often wish to reward their key employees for their leadership, longevity, and performance. Group term life insurance offers some benefits, but for these key employees, the disadvantages outweigh any advantages.
What is the solution? Many businesses choose to “carve-out” or separate these key employees from a group term plan and replace their benefits with individual life insurance policies – typically those that build cash value over time. The rest of a company’s employees still receive benefits under a group plan, but the employer is better able to provide valuable incentives to its key employees by carving them out from group coverage. This solution also provides important benefits for employer and employee alike. These include:
- As mentioned earlier, carving out key employees for additional benefits does not impact the benefits provided under a group term plan.
- Depending on the carve-out option selected by the employer, policies for key employees may build cash value, helping to supplement retirement income for those employees.
- Typically, the cost for employers to provide a carve-out option for key employees is less than the same coverage under a group term life insurance plan.
- Taxable income derived from the carve-out insurance coverage for key employees may be reduced or even eliminated.
Stay Tuned for Part 2 on Group Term Carve-outs
In our next blog post (part two of this series on group term plans and carve-outs), we will discuss how group carve-out plans work and some of the options available to employers in providing this benefit to key employees. Finally, we will provide a checklist for employers to help them determine if this solution is right for their needs.
It’s done! Here is part 2: A Deeper Look at Group Carve-Out Plans