Life Insurance: Should Employers Offer It?

Life insurance is a crucial benefit that employers may offer to their employees. It is typically referred to as basic group life and acts as a safety net for employees and their families in unforeseen circumstances. While it is not mandatory for employers to provide life insurance, it is a valuable addition to a benefits package, incentivising employees and ensuring peace of mind.

What are the benefits of employer-provided life insurance?

There are several benefits to getting life insurance through your employer.

Convenience and ease of enrollment

The first is convenience. Life insurance offered by your employer can make enrollment easier. You won't need to worry about finding the ideal provider or going through the lengthy process of receiving an individual quote. In many cases, these are no-exam life insurance plans. Instead, you inform your employer of your desire to enroll in its coverage, which typically occurs during open enrollment or new employee onboarding, and answer a few questions to activate your policy.

Potential group discounts and lower life insurance premiums

The main advantage of signing up for an employer-sponsored life insurance plan is receiving the discounts you may get by doing so. Your company will likely help you pay your life insurance premiums or, in many cases, cover them entirely up to a certain amount of coverage. This leads to you getting life insurance coverage at a lower out-of-pocket cost.

No medical underwriting required

Another advantage of employer life insurance plans is that you often don't need to complete a medical exam to qualify. This saves you time and may allow you to qualify for coverage you might not have on your own if you had to complete a medical exam, especially if you would require a high-risk insurance policy.

Acceptance

Most employee life insurance plans are guaranteed, meaning you'll be accepted whether or not you have serious medical conditions.

Early protection

When you're just starting out or early in your career, you may not have the funds needed for life insurance. Employee life insurance can provide a degree of financial security for those who depend on you.

Added coverage

You can usually increase your coverage as life events and needs change. An employer may offer the option of paying an additional premium amount to increase basic protection.

Riders for extra protection

An employer may offer riders (e.g., for certain degrees of illness and disability) to your basic policy that you may purchase for added protection.

What are the drawbacks of employer-provided life insurance?

While employer-provided life insurance can be a good benefit, there are several drawbacks to consider.

Insufficient Coverage

In most cases, employer-provided life insurance is not enough to meet the financial needs of the insured's family. It is typically based on a multiple of the employee's salary, usually one year's salary, or a flat amount. However, if the employee has a mortgage, a spouse, dependents, or other financial obligations, this may not be sufficient. Most experts recommend having life insurance coverage of at least 7-10 times your annual salary.

Loss of Coverage Upon Leaving Employment

Another significant disadvantage of employer-provided life insurance is that it is usually tied to your employment. If you leave your job, your insurance coverage will end. As people often change employers multiple times throughout their careers, this can lead to gaps in life insurance coverage. By the time you leave your job, you will likely be older, and purchasing a new individual life insurance policy at that point may be more expensive, especially if your health has declined.

Limited Customization and Control

Employer-provided life insurance policies often offer limited customization options, and you may not be able to choose the insurance company or the type of policy you prefer. The features and coverage amounts are typically predetermined by the employer, and you may not have the same level of control over the policy as you would with an individual plan.

Service Limitations

Additionally, the service provided by your employer or HR department regarding life insurance may be limited compared to the personalized service and advice you can receive from an independent insurance agent. An independent agent can offer more tailored guidance and develop a long-term relationship to better understand your evolving insurance needs.

Tax Implications

In some cases, there may also be tax implications with employer-paid life insurance plans. While benefits up to $50,000 are generally not taxable, amounts exceeding this threshold may be considered taxable income for the employee.

Therefore, while employer-provided life insurance can be a convenient and cost-effective option, it is important to carefully consider these drawbacks and assess whether additional coverage or an individual policy is necessary to ensure adequate financial protection for yourself and your loved ones.

How much life insurance is the right amount?

The right amount of life insurance depends on your financial and family situation. Your savings, debts, income, and family situation all play a role in figuring out how much life insurance you need.

You want a death benefit amount that will provide funds to cover the items your family will need money for. For instance, if you want life insurance to replace your income if you were to die, you need a policy with a much higher death benefit than if you want a policy to simply pay for your final expenses and burial.

There are multiple formulas to calculate potential life insurance needs, including multiplying your income by 10 and the DIME (debt, income, mortgage, and education) method. However, these methods don't offer a full financial picture.

Another way to calculate your life insurance needs is to use a life insurance calculator. You can also determine your life insurance need with this basic equation:

Add up the financial obligations you want to cover. Subtract existing assets that can be used toward bills = Your life insurance need

Here’s what you might include in financial obligations to cover:

• Income replacement: Multiply the salary you want to replace for the number of years you want to replace it. You want this income replacement to cover current and future expenses.
• A mortgage: You can include the balance of a mortgage so your family can stay in their home without fear of losing it.
• Other large debts: Would your family struggle with other large debts if you passed away unexpectedly? If so, add those amounts to the total.
• Children's college tuition: Add tuition money to ensure your children can pay for college if you were no longer around.
• Existing life insurance: Subtract any other life insurance that you already have. Be careful about relying on supplemental life insurance from work—it doesn’t go with you if you leave your job, so you can’t be sure you’ll have it later on.
• Savings: Subtract any savings your family would use to pay expenses. You can include retirement savings such as a 401(k) plan, or leave it out of your analysis if your beneficiaries want to preserve that money for retirement years.
• Funeral expenses: Many people want life insurance to cover funeral and final expenses.

Most group-term policies offer either a set amount of insurance (for example, a $10,000 policy for each employee) or are based on the employee's salary (for example, policy values of one, two, or three times the employee's yearly salary).

In general, you should add up your long-term financial obligations, such as mortgage payments or college fees, and then subtract your assets. The remainder is the gap that life insurance will have to fill.

What are the tax implications of employer-provided life insurance?

Life insurance is a financial product that pays out a lump sum to beneficiaries and heirs in the event of the insured's death. It is intended to provide financial support to the insured's beneficiaries. The Internal Revenue Service (IRS) treats life insurance differently from other types of financial products.

When an employer provides life insurance as part of an overall compensation package, the IRS considers the benefit as income, which means the employee is subject to taxes. However, these taxes only apply when the employer pays for more than $50,000 in life insurance coverage. The premium cost for the first $50,000 in coverage is exempt from taxation.

If an employer provides an employee with $50,000 in life insurance coverage in addition to their salary, health benefits, and retirement savings plan, the employee doesn't have to pay taxes on the life insurance benefit because it does not exceed the threshold set by the IRS. Alternatively, if an employer pays for a $100,000 life insurance policy, the employee must pay taxes on part of that amount. The taxable amount is based on IRS tables, regardless of the actual premium paid. For example, a 70-year-old receiving $50,000 in insurance coverage above the threshold is considered to have $103 per month in additional taxable income, or $1,236 per year.

The cost of group term life insurance must be determined under a table prepared by the IRS, even if the employer's actual cost is less than the cost figured under the table. With these determinations, the amount of taxable phantom income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy. This tax trap gets worse as an employee gets older and as the amount of their compensation increases.

If you decide that the tax cost of employer-provided group term life insurance is higher than you’d like, first, establish if this is the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost of providing you with group term life insurance coverage in excess of $50,000, less any amount you paid for the coverage. You’re responsible for federal, state, and local taxes on the amount that appears in Box 12, and for the associated Social Security and Medicare taxes as well.

However, keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2, and it’s the Box 1 amount that’s reported on your tax return.

What are the alternatives to employer-provided life insurance?

There are several alternatives to employer-provided life insurance. Here are some options to consider:

Income Protection Insurance:

Income protection insurance provides a monthly, tax-free income if you are unable to work for an extended period due to an illness or injury. It offers coverage for 12-60 months and pays between 50%-70% of your earnings. There is a deferral period of 4-26 weeks before payments start. This can be an alternative to life insurance if you are unable to qualify or renew your policy.

Guaranteed Coverage Plan:

A guaranteed coverage plan does not require a medical exam or records. You are generally eligible unless you exceed the age limit, typically set between 50-80 years old. While it may have high premiums, it can be an alternative if you've been denied standard life insurance due to medical factors. The death benefit is usually capped at around $25,000.

Critical Illness Insurance:

Critical illness insurance provides a tax-free lump sum if you develop a life-threatening illness. It primarily replaces income rather than providing a death benefit. Some policies have no waiting period, allowing immediate access to funds for treatment or living costs during recovery. Coverage amounts vary, typically between $5,000 and $75,000, depending on the premiums.

Accidental Death and Dismemberment (AD&D) Insurance:

AD&D insurance covers fatal accidents or the accidental loss of a limb. It does not consider your medical history or lifestyle choices, potentially offering coverage even if you would otherwise be disqualified for life insurance. In the event of an accident or loss of a limb, you receive a tax-free lump-sum payment. Premiums are typically very affordable, around $7 to $10 per month per $100,000 of coverage.

Mortgage Protection Insurance:

Mortgage protection insurance pays off the remaining balance of your mortgage if you pass away or become disabled. The payout covers the mortgage principal and interest, going directly to your mortgage lender. While this won't leave anything for loved ones, it ensures your home isn't lost. You may also be able to get a rider to help cover additional costs like property taxes and insurance. Premiums vary depending on age, the number of years left on the mortgage, and the current balance.

Pre-paid Funeral Plan:

A pre-paid funeral plan covers the expenses associated with a funeral, typically ranging from $10,000 to $25,000. You can pay upfront or in monthly installments, alleviating the financial burden on loved ones during the grieving process.

Asset-Based Long-Term Care Insurance:

This hybrid insurance combines long-term care coverage with an investment component. The investment component involves investing premiums into a fixed or variable annuity, building cash value over time. This cash value can pay for long-term care services, and any remaining proceeds can be passed on as a death benefit. These policies are highly customizable, allowing policyholders to choose coverage amounts, terms, and investment types.

Self-Funded Savings:

If you are not eligible for insurance or prefer not to maintain coverage, you can create your own savings to provide for loved ones. This could involve allocating your income or reallocating your portfolio to maximize interest, ensuring a benefit for dependents when you pass away.

While employer-provided life insurance can be convenient and affordable, these alternatives offer individuals greater control over their coverage and can address specific needs, such as income protection or final expenses.

Frequently asked questions