How Does Life Insurance Work Through an Employer?

Life insurance offered through an employer is a common benefit designed to provide financial protection for employees and their families. This type of coverage typically falls under a group policy, where the employer acts as the policyholder. While it offers a convenient and often cost-effective way to secure coverage, employer-provided life insurance has distinct characteristics and considerations compared to individual policies that individuals purchase on their own.

Types of Employer-Sponsored Life Insurance

Employer-sponsored life insurance generally comes in two primary forms: basic group life insurance and voluntary or supplemental life insurance. Basic group life insurance is often provided automatically to all eligible employees, usually at no direct cost to the employee. The coverage amount for basic plans is typically a fixed sum, such as $25,000 or $50,000, or a multiple of the employee’s annual salary, often one or two times annual salary. Employers usually pay the premiums for this basic coverage.

Voluntary or supplemental life insurance offers employees the option to purchase additional coverage beyond the basic amount. This extra coverage is usually elected by the employee, who then pays the premiums, typically through payroll deductions. A benefit of voluntary plans is that they often allow employees to extend coverage to their spouses and children, providing broader financial protection. These policies are usually offered at group rates, which can be more favorable than rates for individual policies purchased outside of employment.

Managing Your Coverage

Once employer-sponsored life insurance is available, employees typically enroll during specific periods, such as new hire orientation or the annual open enrollment window. Basic coverage might be automatic upon eligibility, meaning employees are enrolled without needing to take action. However, electing voluntary or supplemental coverage generally requires an active choice from the employee.

A crucial step in managing any life insurance policy is designating and regularly reviewing beneficiaries. These are the individuals or entities designated to receive the death benefit. This designation is often completed through the employer’s human resources portal or via specific forms. It is important to ensure that primary and contingent beneficiaries are clearly named, along with their respective percentages, to ensure benefits are distributed as intended. Life events such as marriage, divorce, or the birth of a child should prompt a review and potential update of beneficiary designations.

Coverage amounts for basic plans are predetermined, often as a salary multiple or a flat sum. For voluntary plans, employees choose their desired coverage amount, but higher amounts may necessitate providing evidence of insurability (EOI). EOI involves answering health questions or, in some cases, undergoing a medical examination to assess the applicant’s health risk. This process is more common when enrolling for higher coverage levels or if an employee enrolls outside the initial eligibility period.

Tax Considerations

The tax implications of employer-provided life insurance involve how premiums are treated and how death benefits are taxed. Generally, premiums paid by an employer for basic group term life insurance coverage up to $50,000 are not considered taxable income to the employee. However, if the employer-provided coverage exceeds $50,000, the cost of the coverage above that threshold is considered “imputed income” and is taxable to the employee. This imputed income is calculated using an IRS Premium Table and is reported as taxable wages on the employee’s Form W-2, typically in Box 12 with Code C. Premiums for voluntary coverage that employees pay themselves are typically made with after-tax dollars.

Upon the death of the insured, the death benefits paid to beneficiaries from employer-sponsored life insurance policies are generally received income tax-free. This tax-free status applies to the lump sum payout. However, if beneficiaries elect to receive the death benefit in installments, any interest accrued on those installments may be subject to income tax.

Leaving Your Employer

When an employee leaves their job, employer-provided group life insurance typically terminates shortly after employment ends. This cessation of coverage can occur on the last day of employment or the last day of the month of termination, depending on the policy terms. This means employees should consider their life insurance needs as they transition between employers.

Some employer plans offer options to continue coverage, primarily through portability or conversion. Portability allows an employee to continue their group term life insurance coverage as a group policy by paying premiums directly to the insurer. While this option maintains the existing coverage without requiring a medical exam, the rates are often higher than those paid under the employer’s group plan. Portability is usually intended to bridge a gap in coverage, such as between jobs.

Conversion rights allow an employee to convert their group term life insurance into an individual permanent life insurance policy, such as whole life insurance, without needing to provide evidence of insurability or undergo a medical exam. This can be particularly beneficial for individuals with health conditions that might make obtaining new individual coverage difficult. Converted policies typically come with higher individual premium rates compared to group rates. Both portability and conversion options usually have strict time limits for election, often requiring action within 30 to 60 days after the group coverage ends.