Group Life Insurance: Pre- Or Post-Tax?

Group life insurance is a financial product that provides a lump sum to beneficiaries in the event of the policyholder's death. When an employer offers group term life insurance as part of a benefits package, the Internal Revenue Service (IRS) considers the first $50,000 of coverage to be tax-free. This means that if the employer-provided coverage is $50,000 or less, the employee does not have to pay taxes on this benefit. However, if the employer pays for coverage exceeding $50,000, the additional amount is considered taxable income for the employee. This taxable amount is determined using IRS tables and is subject to social security and Medicare taxes. Understanding the tax implications of group life insurance is crucial for both employers designing benefits packages and employees making financial decisions.

Group-term life insurance coverage: The first $50,000 is tax-free

Group-term life insurance coverage is a contract issued to employees, offered by employers as an employee benefit. The Internal Revenue Service (IRS) considers employer-provided group-term life insurance tax-free if the policy's death benefit is less than $50,000. This exclusion is provided by IRC section 79. If the coverage exceeds $50,000, the imputed cost of coverage must be included in the employee's income and is subject to social security and Medicare taxes.

The taxable value of the excess coverage is determined using the IRS Premium Table, also known as "Table I". This table indicates the cost of coverage based on the employee's age and may differ from the actual premium paid. For example, a 70-year-old receiving $50,000 in insurance coverage above the threshold is considered to have $103 in additional taxable income per month, or $1,236 per year.

Group-term life insurance can be offered through a cafeteria plan, where employees can purchase some or all of their coverage with pre-tax salary reduction contributions. Under IRS regulations, these pre-tax salary reductions are treated as employer contributions and are not subject to federal income or employment taxes, as long as the total coverage does not exceed $50,000.

If employees purchase more than $50,000 of coverage with pre-tax contributions, the value of the coverage in excess of $50,000 will be subject to federal income and FICA taxes. The after-tax premiums will reduce the taxable coverage value dollar for dollar. This taxable amount is referred to as "imputed income", which is subject to FICA taxes but not federal income tax withholding.

It is important to note that life insurance premiums are generally not tax-deductible. However, there are certain circumstances where they can be deducted as a business expense if the policy owner is not directly or indirectly a beneficiary of the policy. Additionally, life insurance proceeds received by beneficiaries are not included in their income and do not need to be reported to the IRS.

Employer-provided insurance: The premium paid on policy amounts above $50,000 is taxable income

In the United States, the Internal Revenue Service (IRS) considers employer-provided group-term life insurance tax-free if the policy's death benefit is less than $50,000. This means that the premium cost for the first $50,000 in coverage is exempt from taxation. However, if an employer pays for a life insurance policy that exceeds $50,000, the employee must include the premium paid on the policy amount above $50,000 as part of their taxable income. This is because the IRS treats employer-provided insurance as income, and the excess coverage is considered a taxable fringe benefit.

The taxable value of the excess coverage over $50,000 is determined using the IRS Premium Table, also known as "Table I," which varies based on the employee's age. For example, if a 42-year-old employee purchases $150,000 of group-term life insurance coverage under a cafeteria plan with $200 of pre-tax salary reduction contributions, the cost of the remaining $100,000 of coverage (as determined by Table I) would be treated as taxable income. In this case, the Table I cost of $100,000 of coverage is $120 per year, so the employee would be taxed on that amount of imputed income. It is important to note that the determination of whether the premium charges straddle the costs is based on the IRS Premium Table rates and not the actual cost.

Additionally, if any portion of an employee's premiums is paid on an after-tax basis, it will reduce the taxable coverage value dollar for dollar. For instance, if the employee in the previous example were allowed to pay for a portion of the coverage with after-tax contributions, and $100 of the premiums were paid with after-tax contributions, the taxable income on the excess coverage would be reduced by that amount. As a result, the employee's imputed income on the $100,000 of excess coverage would be $20 ($120 minus $100).

The tax consequences of employer-provided group-term life insurance coverage can be complex, and it is always recommended to consult with a tax professional or advisor to ensure compliance with IRS regulations and to understand the full tax implications for both employers and employees.

Pre-tax salary reductions: Treated as employer contributions and not subject to federal income tax

In the US, group-term life insurance is governed by Internal Revenue Code (IRC) Section 79, which provides an exclusion for the first $50,000 of coverage provided under a policy carried directly or indirectly by an employer. This means that there are no tax consequences for the employee if the total amount of such policies does not exceed $50,000. The cost of coverage in excess of $50,000 must be included in the employee's gross income and is subject to federal income tax and Federal Insurance Contributions Act (FICA) taxes, which include Social Security and Medicare taxes.

Group-term life insurance coverage can be offered through a cafeteria plan, with employees purchasing some or all of their coverage with pre-tax salary reduction contributions. Under IRS regulations, these pre-tax salary reductions are treated as employer contributions and are not subject to federal income or employment taxes. Code § 79 allows employees to exclude from their gross income the cost of up to $50,000 in employer-provided group-term life insurance coverage. Therefore, if employees purchase no more than $50,000 of coverage with pre-tax contributions under a cafeteria plan, they will not pay federal taxes on the coverage.

If employees purchase more than $50,000 of coverage with pre-tax contributions, the pre-tax premiums remain tax-free, but the value of the coverage in excess of $50,000 becomes subject to federal income and FICA taxes. The taxable value of the excess coverage is determined using its cost as indicated in an IRS table called "Table I". The Table I cost of coverage varies based on the employee's age and may differ from the actual premium paid by the employee. If any portion of an employee's premiums are paid on an after-tax basis, the after-tax premiums will reduce the taxable coverage value dollar for dollar. This taxable amount is sometimes referred to as "imputed income" and, while it is not subject to federal income tax withholding, FICA taxes must be withheld.

For example, if a 42-year-old employee purchases $150,000 of group-term life insurance coverage under a cafeteria plan with $200 of pre-tax salary reduction contributions, the first $50,000 of coverage would not be taxed. However, the cost of the remaining $100,000 of coverage, as determined by Table I, would be treated as taxable income to the employee. In this case, the Table I cost of $100,000 of coverage for a 42-year-old is $120 per year, so the employee would be taxed on that amount of imputed income. If the employee paid $100 of the premiums with after-tax contributions, the taxable income on the excess coverage would be reduced to $20 ($120 minus $100).

Post-tax salary: The most common type of post-tax life insurance deduction

Post-tax benefit contributions, also known as after-tax deductions, are taken from an employee's paycheck after taxes have already been deducted. While post-tax deductions don't provide immediate tax relief, they won't be taxed when the benefits are used in the future. This makes them preferable for employees compared to pre-tax deductions.

The most common type of post-tax life insurance deduction is group-term life insurance. Group-term life insurance coverage is a contract issued to employees by employers as an employee benefit. The Internal Revenue Service (IRS) considers employer-provided group term life insurance tax-free if the policy's death benefit is less than $50,000. Coverage over $50,000 must be paid post-tax.

Some employers make basic term life insurance available to their employees at no additional cost up to a certain coverage amount. For example, an employer may offer $50,000 of coverage at no cost to the employee, but anything over this amount will result in imputed income, which must be paid post-tax. If employees want to add supplemental coverage or purchase life insurance for a dependent, these funds are typically deducted from their pay on a post-tax basis.

It's important to note that the tax treatment of life insurance benefits can be complex, and specific rules and regulations may vary depending on your location. It's always a good idea to consult with a tax professional or advisor to understand the specific tax implications of your group-term life insurance plan.

Pre-tax vs post-tax benefits: Pre-tax provides immediate tax break, post-tax doesn't reduce overall tax burden

Group-term life insurance is a contract issued to employees, offered as an employee benefit. The Internal Revenue Service (IRS) considers employer-provided group term life insurance tax-free if the policy's death benefit is less than $50,000. Coverage over $50,000 must be paid post-tax.

Pre-tax benefits:

Pre-tax benefits are deducted from an employee's paycheck before federal income and employment taxes are applied. This lowers the employee's total taxable income, reducing the amount of federal income tax they have to pay. A pre-tax deduction also lowers tax liabilities for employers. However, the employee might owe taxes in the future when they use the benefit. For example, an employee who retires will owe taxes when they withdraw money from a pre-tax 401(k) plan.

Common examples of pre-tax benefits include:

• Health insurance plans
• Health reimbursement arrangements (HRAs)
• Health savings accounts (HSAs)
• Pre-tax retirement plans
• Commuter benefits

Post-tax benefits:

Post-tax benefit contributions are taken from an employee's paycheck after taxes have already been deducted. Since post-tax deductions reduce net pay rather than gross pay, they don't lower the individual's overall tax burden. The employee typically won't owe any income tax on the benefits when they use them in the future. For example, an employee who retires will not owe additional taxes when they withdraw money from a post-tax retirement plan.

Common examples of post-tax benefits include:

• Stipends
• Post-tax retirement plans
• Disability insurance
• Wage garnishment

Frequently asked questions