What Is Group Term Life Insurance & How It Works?
Understand Group Term Life Insurance: its purpose, operational details, and tax considerations as an employee benefit.
Group term life insurance is a common benefit offered by employers to their workforce. This type of insurance provides financial protection to employees’ beneficiaries if the insured individual passes away while the policy is active.
Understanding Group Term Life Insurance
Group term life insurance is a single policy designed to cover multiple individuals, typically employees of an organization. It combines three distinct concepts: “group,” “term,” and “life insurance.” The “group” aspect means coverage extends to a collective, like all eligible employees, rather than being purchased individually. This collective approach often results in lower premiums compared to individual policies because the risk is spread across many people.
The “term” characteristic means coverage is for a specific period, usually aligning with employment. Unlike permanent life insurance, group term policies do not accumulate cash value and terminate when an employee leaves their job. The “life insurance” component ensures a predetermined lump sum, known as a death benefit, is paid to designated beneficiaries upon the insured’s death while the policy is in effect. Group term life insurance plans typically do not require medical examinations or extensive individual underwriting, simplifying access for eligible employees.
How Group Term Life Insurance Operates
Group term life insurance is sponsored by an employer, who holds the master policy covering their employees. Eligibility is determined by the employer and insurer, often requiring full-time status or completion of a probationary period. Employers provide a base amount of coverage at little to no cost to the employee as part of their standard benefits.
Coverage amounts vary, calculated as a multiple of an employee’s annual salary or a flat amount. For example, an employee might be covered for one or two times their salary, or a fixed amount like $50,000. Employees can purchase supplemental coverage beyond the basic employer-provided amount through payroll deductions. While employers pay most or all premiums for basic coverage, the cost for additional coverage may be shared or fully borne by the employee.
Enrollment for basic coverage is often automatic for eligible employees, which contributes to its convenience. Changes in coverage or the election of supplemental insurance typically occur during open enrollment periods or following qualifying life events, such as marriage or the birth of a child.
Taxation of Group Term Life Insurance
The tax implications of group term life insurance affect both employers and employees. Premiums paid by employers for group term life insurance are a tax-deductible business expense for the employer, provided the employer is not the beneficiary of the policy. This deduction can reduce the company’s taxable income.
For employees, the tax treatment of group term life insurance coverage is governed by Internal Revenue Code Section 79. Under this section, the cost of the first $50,000 of employer-provided group term life insurance coverage is excluded from an employee’s gross income. However, if the coverage amount exceeds $50,000, the cost of the coverage above this threshold is considered taxable income to the employee. This taxable amount is referred to as “imputed income” and is subject to Social Security and Medicare taxes.
The imputed income is calculated using the IRS Uniform Premium Cost Table based on the employee’s age, rather than the actual premium paid by the employer or employee. The death benefit paid to beneficiaries from a group term life insurance policy is excluded from their gross income for federal income tax purposes.