What Is Employee Life Insurance and How Does It Work?
Navigate employee life insurance. Understand this essential workplace benefit, how it provides financial security, and its practical and tax implications.
Employee life insurance is a valuable benefit employers offer to their workforce. This coverage provides financial protection to an employee’s designated beneficiaries following their death. Its primary purpose is to help ensure financial stability for loved ones, assisting families with expenses such as funeral costs, daily living expenses, or outstanding debts.
Types of Employee Life Insurance
Employers offer various categories of life insurance to meet diverse employee needs. Group term life insurance is a common offering, often provided by the employer at no direct cost to the employee. This coverage remains active for a specific period, generally coinciding with the employee’s tenure, with amounts often set as a multiple of salary or a predetermined flat sum.
Voluntary or supplemental life insurance allows employees to purchase additional coverage beyond the basic group policy. Employees pay the full premiums for this extra protection, often through payroll deductions. Dependent life insurance extends coverage to an employee’s spouse or children, typically in smaller, fixed amounts.
Accidental Death and Dismemberment (AD&D) insurance is another type, often bundled with standard life insurance, but it operates differently. AD&D policies only pay out if death occurs due to an accident, or if the insured suffers specific accidental injuries, such as the loss of a limb or sight. This coverage focuses solely on accidental events, unlike traditional life insurance which covers death from most causes.
Key Characteristics of Group Policies
Employee life insurance policies come with several features. Eligibility for coverage often depends on factors such as full-time employment status. Enrollment typically occurs during initial onboarding or annual open enrollment periods, and employees are usually given a window to sign up for or adjust their coverage.
Designating beneficiaries is a key step in setting up life insurance, ensuring the policy’s proceeds are distributed according to the employee’s wishes. It is important to keep this information current to reflect any life changes. Coverage amounts vary, with basic plans providing a flat sum or a multiple of salary, while supplemental plans allow for higher, employee-selected coverage levels.
Many group policies include portability and conversion options when an employee leaves the company. Portability allows an employee to continue their group coverage by paying premiums directly to the insurer. Conversion options enable an employee to change their group coverage into an individual policy without a medical exam, though the premiums for a converted policy are higher. Some policies also feature a waiver of premium, where premiums may be suspended if the employee becomes totally disabled. An accelerated death benefit provision allows an employee diagnosed with a terminal illness to access a portion of their death benefit while still living.
Tax Considerations
The tax implications of employee life insurance can affect both the employee and the employer. For group term life insurance provided by an employer, the cost of coverage exceeding $50,000 is considered taxable income to the employee. This amount, known as imputed income, is subject to Social Security and Medicare taxes. Premiums paid by employees for voluntary or supplemental coverage are generally paid with after-tax dollars and are not deductible.
Death benefits received by beneficiaries from a life insurance policy are generally not subject to federal income tax. However, there are specific situations where taxes may apply. If the death benefit payout is delayed and accrues interest, that earned interest becomes taxable income for the beneficiary. If the life insurance proceeds are payable to the deceased’s estate and the estate’s value exceeds federal estate tax thresholds, beneficiaries may incur estate taxes. Receiving the death benefit as an annuity, rather than a lump sum, can also result in the interest portion of the payments being taxable.
For employers, premiums paid for group term life insurance are generally tax-deductible as a business expense. This deduction applies as long as the employer is not directly or indirectly a beneficiary of the policy.