Group Life Insurance

Group life insurance is life insurance issued to an employer, union or association under one master contract that covers a defined group of people, with each covered person receiving a certificate rather than an individual policy. In the workplace it is almost always group-term life insurance, which is also the name the tax code uses: section 26 U.S.C. 79 is titled "Group-term life insurance purchased for employees," and it is that hyphenated statutory phrase, rather than the broader market term, that governs the tax treatment described below. Group permanent coverage exists and is far less common. Voluntary or supplemental amounts an employee buys through the same workplace arrangement are a related but separately priced product.

Three characteristics define what group coverage is worth to a particular person, and they pull in different directions. It is usually available without individual underwriting up to a stated limit, so it reaches people who would struggle to buy coverage on their own health. It is priced on the group, which makes it inexpensive for someone in poor health and occasionally more expensive than an individually underwritten policy for someone young and healthy. And it is tied to the employer, so it generally ends with the job, leaving at most a conversion right that has to be exercised inside a short window and usually converts to a permanent form at a much higher price. Regulators put this plainly: group coverage is not likely to be transferable to another job. Portability provisions, where a plan offers them, let some employees keep the group term coverage for a period; conversion is the different and more expensive route into an individual permanent contract. A plan may offer one, both or neither.

The tax mechanics are where this page earns its keep, because the arithmetic surprises people every year. Section 79(a) includes in income the cost of employer-provided group-term coverage, but only to the extent that cost exceeds the sum of two things: the cost of $50,000 of such insurance, and the amount the employee paid toward it. Both subtractions are in the statute, and the second is routinely forgotten. The cost figure itself is not the employer's actual premium. Section 79(c) directs that it be determined on the basis of uniform premiums computed in five-year age brackets, and the resulting table lives in the regulations at 26 CFR 1.79-3(d)(2). The rate is per $1,000 of excess coverage per month, the age used is the employee's age on the last day of the tax year, and the amounts rise steeply through the older brackets. Two consequences follow. The table can produce a figure higher or lower than the employer's real cost. And the taxable amount grows every few years as the employee crosses a bracket, even though the coverage has not changed, which is the usual explanation for a pay-stub line that keeps increasing.

How that amount is taxed is itself unusual, and it is the part most likely to produce an unwelcome result at filing. The excess cost is reported as wages in boxes 1, 3 and 5 of Form W-2 and again in box 12 with code C. It is subject to Social Security and Medicare tax. But the employer is not obliged to withhold federal income tax on it and does not owe federal unemployment tax on it, so the income tax on a large imputed amount may be entirely unwithheld. Anyone carrying a high multiple of salary in group coverage into their sixties is the most exposed to this.

Two further rules narrow the exclusion in ways plan participants rarely hear about. Under section 79(d), if a plan discriminates in favor of key employees as to eligibility or benefits, a key employee loses the $50,000 exclusion entirely and is taxed on the greater of the employer's actual cost or the table cost, which is one of the few places the tax code deliberately picks the larger of two figures. And employer-paid coverage on a spouse or dependent may be excluded as a de minimis benefit where the face amount is no more than $2,000; above that, the exclusion becomes a facts-and-circumstances question rather than a rule. Separately, section 79(b) removes the general rule altogether in three situations, the most useful of which is coverage continued after employment ends for someone who is disabled.

An employer chooses a benefit formula, commonly a flat amount or a multiple of salary, and the insurer issues one policy covering everyone who qualifies. Employees name their own beneficiaries, and the beneficiary designation on file with the plan is what controls who is paid, not a will. Where the plan offers supplemental amounts, the employee pays for those, sometimes with evidence of insurability required above a threshold.

A hypothetical example of the imputed-income calculation. Suppose an employer provides $200,000 of group-term coverage to an employee who is 45 at the end of the year and who pays $100 toward the coverage during the year. Only the excess over the statutory exclusion is measured, so $200,000 less $50,000 leaves $150,000 of coverage in scope. The employer looks up the monthly rate for the 45-to-49 bracket in the regulation's table, multiplies it by 150 for the number of $1,000 units, and multiplies by the months of coverage. If that produced $270 for the full year, the amount reported would be $270 less the $100 the employee paid, or $170, appearing in boxes 1, 3 and 5 and again in box 12 with code C. Social Security and Medicare tax apply to the $170; income tax on it may not have been withheld at all.

The practical question the numbers lead to is whether a multiple of salary is the right amount of coverage, which is a different question from what the coverage costs. A household works out what the money would have to do and subtracts what already exists, and group coverage counts on the resource side of that subtraction rather than answering it. Because the coverage ends with the job and cannot be relied on across a career, anyone whose need is large or long-lived generally has to own a policy outright as well, and that has to be bought while they are healthy enough to qualify.

Pros

• Usually available with no medical exam up to a stated limit, which makes it the only accessible coverage for some people.
• Inexpensive, and often free for the employer-paid base amount.
• The first $50,000 of employer-provided coverage is excluded from income outright, with no application or election needed.
• Group pricing works in favor of anyone whose own health would make individual coverage expensive.

Cons

• It ends when the job does, at the moment a health change may have made individual coverage costly or unavailable.
• Coverage above $50,000 produces imputed income that grows with age, and the income tax on it is frequently not withheld.
• A default multiple of salary is a plan design decision, not an assessment of what a household needs.
• The conversion right, where one exists, is usually to an expensive permanent form and must be exercised quickly.
• A key employee in a plan that discriminates in their favor loses the $50,000 exclusion and is taxed on the greater of two measures of cost.