Life Insurance For Employees: What's The Best Option?

Life insurance is an important benefit that employers can offer their employees. It is typically offered as an optional benefit, and employers can choose who should be covered, what type of insurance to offer, and how much insurance is optimal and affordable. Most employers offer group-term life insurance, which is often cheaper than individual plans and can be offered at no cost to the employee. However, it is usually temporary and tied to the employee's job, with limited coverage amounts.

How much life insurance is enough?

The amount of life insurance you need depends on your financial goals and needs. If you have loved ones who depend on your income, life insurance can help cover funeral and burial expenses, pay off remaining debts, and make managing day-to-day living expenses less burdensome for those you leave behind.

• Income replacement: A common guideline is to have enough life insurance to replace 10 times your annual income. This will provide your dependents with a financial cushion and help maintain their standard of living.
• Outstanding debts: Ensure your policy includes enough coverage to pay off any debts you may have, such as mortgages, car loans, credit card debt, or personal loans.
• Future needs: Consider any future expenses your dependents may have, such as college tuition or medical bills.
• Number of dependents: If you have multiple dependents, you may need a higher level of coverage to ensure their financial security.
• Spousal coverage: Even if only one spouse is the primary breadwinner, it is essential to consider the contributions of the other spouse, such as childcare or household management.
• Existing assets: Take into account any existing assets, such as investments or retirement accounts, that can provide financial support for your dependents.
• Cost of living: Factor in the cost of living in your area when calculating the necessary coverage amount.
• Policy type: The type of policy you choose, such as term or permanent life insurance, will impact the cost and duration of coverage.
• Health and age: Your age and health status can affect the cost of premiums. Generally, the younger and healthier you are, the lower your premiums will be.
• Riders and additional benefits: Consider any additional benefits or riders you may want to include in your policy, such as accidental death or long-term care coverage, as they can increase the cost.

It is important to regularly review and adjust your life insurance coverage as your life circumstances change, such as getting married, having children, or experiencing a significant income increase.

What are the tax implications?

If you're considering offering life insurance as an employee benefit, it's important to understand the tax implications for both your business and your employees. Here are some key points to keep in mind:

• Group-term life insurance: The cost of premiums for the first $50,000 of group-term life insurance is generally not included in the employee's gross income for tax purposes. This means it's tax-free for the employee. However, if the coverage exceeds $50,000, the premium cost above this amount is considered taxable income for the employee. This additional income is often referred to as "phantom income" and can result in higher taxes.
• Nondiscrimination requirements: If you want to offer life insurance as a special benefit to a few key employees, you won't be able to deduct the premiums for federal tax purposes unless you meet certain nondiscrimination requirements. These requirements are designed to discourage providing benefits only to highly compensated employees or in a way that limits lower-compensated employees from participating due to the price. To meet these requirements, the plan must benefit at least 70% of all employees, at least 85% of participating employees are not key employees, or the plan benefits employees who qualify under a non-discriminatory classification set by the employer and approved by the IRS.
• Retiree coverage: You can also offer life insurance to retirees of your business. If you decide to do so, the same tax rules apply as for active employees. The cost of premiums for the first $50,000 of coverage is tax-free, but premiums paid above this amount are considered taxable income for the retiree.
• Employee contributions: If your employees contribute towards the cost of their life insurance coverage, any amount they contribute will reduce the taxable amount. For example, if you pay the premiums on a $175,000 group-term life insurance policy and the employee contributes $11 per month, the taxable amount included in their gross income would be $348 for the year.
• Reporting and withholding: As an employer, you are responsible for reporting the taxable amount of life insurance premiums on your employees' Form W-2. Employees can also choose to have federal income tax withheld from their life insurance benefits by submitting a Form W-4S to the insurance company.
• State and local taxes: In addition to federal income tax, employees may also be subject to state and local income taxes on the value of their life insurance coverage above $50,000. They may also be liable for associated Social Security and Medicare taxes.
• Business taxes: As an employer, you will also be responsible for payroll taxes on the value of the life insurance coverage you provide above $50,000. This includes Social Security, Medicare, and federal unemployment taxes.
• Other types of insurance: If you offer other types of insurance, such as group accidental death and dismemberment or split-dollar life insurance, different tax rules may apply. It's important to consult with a tax professional to understand the tax implications of these benefits.

What are the pros and cons of employer-provided life insurance?

Pros of employer-provided life insurance:

• It's free or low cost.
• It's easy to sign up for.
• It's guaranteed, meaning you'll be accepted regardless of any serious medical conditions.
• It provides early protection for those who are just starting out in their career and may not have the funds needed for life insurance.
• You can usually increase your coverage as life events and needs change.
• It can be supplemented with riders for extra protection.

Cons of employer-provided life insurance:

• It's often not portable, meaning you may lose your insurance if you leave your job.
• There is a limited choice of policies.
• Coverage amounts are typically low and may not be enough to meet your financial needs, especially if you have dependents.
• Premiums aren't fixed and tend to increase over time.
• If your employer pays for your coverage, the premiums for coverage over $50,000 may be subject to income tax.

How do I decide if group life insurance is right for me?

Group life insurance is a common employee benefit that provides a death benefit to the insured's beneficiaries if they die while part of the organization. It is a single contract for life insurance coverage that extends to a group of people. Group life insurance is generally less expensive than individual life insurance because the employer pays all or most of the cost. It is also easy to get as it is often part of the onboarding process and there is no medical exam required.

However, group life insurance is limited by its nature. When a policy is designed for a diverse group of people, it rarely caters to all the individual needs within that group. This can lead to paying for coverage you don’t want and not getting the coverage that you do want. Further, you lose the ability to tailor your premium payments and death benefit payout to your needs and situation.

• Cost: Group life insurance is generally inexpensive or free for the employee, whereas individual life insurance policies tend to be more expensive.
• Coverage: The amount of coverage available to you may differ depending on where you are in the organizational hierarchy. Benefits for highly paid executives and managers may be more robust than those offered to lower-level or hourly employees. Group life insurance also generally comes with only basic coverage, which means it may not fulfill the needs of policyholders.
• Portability: Group life insurance is often not portable, meaning that if you leave your job, you may not be able to take the policy with you.
• Death benefit: The death benefit of a group life insurance policy is usually lower than that of an individual policy.
• Additional coverage: You may be able to purchase supplemental life insurance from your employer, which may be offered at a lower rate than an individual policy.
• Customisation: With group life insurance, you generally do not have the option to customise your coverage. Individual life insurance policies, on the other hand, offer more flexibility in terms of coverage amounts, lengths of coverage, and additional riders.

In summary, group life insurance can be a good option if you are looking for a basic level of coverage at a low cost. However, if you have specific needs or require a higher level of coverage, an individual life insurance policy may be a better fit.

What are the steps to offering life insurance as an employee benefit?

Offering life insurance as an employee benefit is completely optional for employers, but it is a popular option for both employers and employees. If you're considering including life insurance in your employee benefit package, here are the steps you can follow:

Step 1: Decide who should be covered

You may want to offer group-term life insurance benefits to all your full-time employees, especially if you can get lower rates with a bigger group. However, if you only want to offer life insurance to a few key employees, you won't be able to deduct the premiums for federal tax purposes unless you meet special nondiscrimination requirements. These requirements are designed to discourage providing benefits only to highly compensated employees or limiting lower-compensated employees' participation due to the price.

Step 2: Determine the type and amount of coverage

Most employers offer group-term life insurance as an employee benefit, but other types can be offered as well. Term insurance is in effect for a certain period, usually as long as the employee is employed. You can offer a set amount of insurance (e.g., a $10,000 policy for each employee) or base it on the employee's salary (e.g., one to three times their yearly salary).

Step 3: Find vendors and administer the plan

Once you've decided on the type and amount of coverage, it's time to contact vendors for price quotes. Ask other business owners or your local chamber of commerce for recommendations. When you've chosen a vendor, they will provide you with the necessary forms to enrol employees, and you should keep a copy of each employee's enrolment document. It's important to impress upon your employees the importance of keeping their beneficiary information up to date.

Step 4: Process claims and handle terminations

In the unfortunate event of an employee's death, you will need to notify your insurance company and complete the necessary forms to start the claims process. If an employee leaves your company, some group-term life insurance policies may allow a conversion privilege, where they can get a private policy through the same insurance agency, although this is usually more expensive.

By following these steps, you can effectively offer life insurance as an employee benefit, providing valuable protection for your staff and their loved ones.

Frequently asked questions