Life Insurance: A Must-Have Employee Benefit?

Life insurance is a valuable benefit that employers can offer to their staff. It can provide financial protection for employees' families, and there are several reasons why employers might want to provide this benefit. However, there are also some potential drawbacks for both employers and employees to consider. This article will explore the advantages and disadvantages of employers offering life insurance and discuss factors such as cost, convenience, coverage, and customisation.

Pros and cons of buying life insurance through work

There are several advantages to getting life insurance through your employer. Firstly, it is convenient as the paperwork is often part of the hiring process and HR departments are available to answer any queries. Secondly, it is often free or low-cost, as employers usually cover the premiums. Thirdly, most basic life insurance plans through work are guaranteed, so even those with serious medical conditions can qualify for coverage.

However, there are also some disadvantages to consider. Group life insurance is often not portable, meaning that if you leave your job, you may lose your coverage. Additionally, the coverage amounts are typically low, and may not be sufficient for your needs, especially if you have dependents or financial obligations. Furthermore, the coverage is usually tied to your job, so if you experience layoffs or unemployment, you could lose your insurance. Finally, the premiums for group life insurance are not fixed and tend to increase over time.

Employer-provided life insurance: what are the tax implications?

Life insurance is often provided by employers as part of an employee benefits package. This is typically "group insurance", meaning one policy covers all employees. While the first $50,000 of group term life insurance coverage that an employer provides is excluded from taxable income, amounts over $50,000 are considered taxable income. This is true even if the employer's actual cost is less than the cost figured under the table prepared by the IRS. The cost of group term insurance must be determined under this table.

The tax implications of employer-provided life insurance are that you are taxed on income you didn’t receive. This is called "phantom income". The employer-paid cost of group term coverage in excess of $50,000 is included in the taxable wages reported on your Form W-2. You are responsible for federal, state and local taxes on the amount that appears in Box 12 of your Form W-2, and for the associated Social Security and Medicare taxes as well. However, 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.

If you decide that the tax cost is too high for the benefit you’re getting in return, you can find out whether your employer has a “carve-out” plan or is willing to create one. The employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can provide the employee with an individual policy for the balance of the coverage. Alternatively, the employer can give the employee the amount they would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.

Should you get life insurance through work?

Life insurance is a crucial part of financial planning, especially if you have people who depend on your income. While health insurance is the main benefit people think of when it comes to employee benefits, life insurance is also an important option to consider.

Advantages of Buying Life Insurance Through Work:

• Convenience: Signing up for life insurance through your employer is simple, as the paperwork is often included in your hiring documents, and HR departments are available to answer any questions.
• Price: Basic coverage through work is typically free or offered at a low cost, making it an affordable way to get a modest amount of coverage.
• Acceptance: Most basic life insurance plans through work are guaranteed, so even individuals with serious medical conditions can obtain coverage.

Disadvantages of Buying Life Insurance Through Work:

• Coverage is Tied to Your Job: Group life insurance is often not portable, meaning that if you leave your job, the policy may not be transferable. You might be able to convert your group policy to an individual one, but the price will likely increase significantly.
• Limited Choice: Coverage through work is usually term life insurance, and employers typically only work with a single carrier, so you won't find the same range of policy options as you would outside of work.
• Low Coverage Amounts: The coverage amounts provided by group life insurance policies are typically capped at low amounts, such as one to two times your annual salary. This may not be sufficient if you have dependents or significant financial obligations.
• Premiums Aren't Fixed: Premiums for group life insurance tend to increase annually or every five years.

Factors to Consider:

• Employer-provided life insurance is usually term life insurance, which remains in effect only for a specific length of time, often tied to your employment.
• The amount of coverage is typically determined using a multiple of your annual salary or your position in the company.
• Employers usually pay most or all of the premiums for this type of insurance.
• It's important to note that employer-provided life insurance generally only applies to the employee, not their spouse or children.

In conclusion, while getting life insurance through your employer can be a convenient and cost-effective option, it's crucial to consider your unique financial situation and whether the coverage provided meets your needs. If you have dependents or significant financial obligations, you may need to supplement your employer-provided insurance with an individual policy to ensure adequate coverage.

What are the drawbacks of employer life insurance?

There are several drawbacks to relying solely on employer-provided life insurance. Here are some key considerations:

Limited Coverage Amounts

The coverage amount provided by employer-based life insurance is typically calculated as a multiple of the employee's annual salary, which may not be sufficient to meet the financial needs of their dependents or family in the event of their death. Most employers offer coverage of around one to two times the employee's salary, but experts recommend having insurance worth five to ten times your annual salary. This discrepancy can leave individuals underinsured, creating anxiety about their family's financial future.

Lack of Portability

Employer-provided life insurance is usually not portable, meaning that if you leave your job, you will lose your insurance coverage. This lack of portability creates uncertainty during job changes or retirement, leaving individuals unprotected during transitions. While some policies allow for converting group policies to individual ones, the cost can be significantly higher.

Limited Choice and Customization

Employer-based insurance often offers limited choice in terms of insurance companies and policy types. It is usually a form of term life insurance, and employers typically work with a single carrier, limiting the range of options available to employees. This lack of customization can be problematic for those seeking more complex products, such as whole life or universal life insurance.

Premium Increases

The premiums for group life insurance tend to increase over time, either annually or every five years. This can make it more expensive to maintain coverage as you age, especially if your health condition changes or deteriorates.

Tax Implications

If your employer pays for your coverage, the premiums for insurance amounts over a certain threshold (e.g., $50,000) may be subject to income tax. This can add an additional cost burden to the employee.

How much life insurance do you need?

How much 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.

There are several methods to calculate the right amount of life insurance coverage:

• Income replacement method: Multiply your income by 10, 5, or 17. This rule of thumb is hard to pin down, and it doesn't consider other factors like savings or existing life insurance policies.
• Multiply income by 10 and add $100,000 per child for college expenses: This formula considers education expenses but still doesn't account for other expenses, assets, or unique situations.
• DIME (debt, income, mortgage, education) method: This method provides a more comprehensive view of your financial obligations by adding up your debt, income, mortgage, and education costs. However, it doesn't take into account your existing financial resources, such as life insurance coverage and savings.
• Replace income and add a cushion: With this method, you buy enough coverage that your beneficiaries can replace your income without spending the payout. They can invest the lump sum and use the income to cover expenses.

To calculate your financial obligations, add up your annual salary, mortgage balance, future needs (e.g., college fees, funeral costs), and the cost of replacing services provided by a stay-at-home parent. Then, subtract your liquid assets, such as savings, college funds, and existing life insurance policies. The remaining amount is the life insurance coverage you need.

It's important to note that the above methods provide estimates, and your specific needs may vary. Life insurance needs are unique to each individual's financial situation, including their dependents and budget. It's recommended to consult with a financial professional to determine the appropriate amount of coverage for your specific circumstances.

Frequently asked questions