I was speaking with a CPA recently who is a partner in a large, successful accounting firm. We were discussing the firm-sponsored group life insurance plan.
He was covered by a typical multiple of salary base plan and had also purchased additional supplemental insurance. He was thinking of retiring, and we discussed whether the employer-sponsored insurance was sufficient for his needs. This was especially important since he had some health issues and is in his late 60’s.
The good news:- He could continue coverage under the multiple of salary base coverage as long as he keeps working.
- Both his base and supplemental life insurance will terminate entirely should he choose to retire.
- His benefits under the base plan will be reduced by 50% at age 70, even if he keeps working.
- His additional supplemental coverage will terminate entirely at age 70, even if he keeps working.
- Even though his salary-based plan benefits will terminate, he could convert the group coverage to a permanent individual policy without taking a physical exam or answering any medical questions.
- The conversion premiums would be very costly, roughly $22,000 per year for $500,000 of coverage at age 70.
- It is possible to implement a guaranteed issue program that would allow the purchase of a less-expensive permanent policy with equal or greater death benefit.
QUESTIONS AND ANSWERS WITH RESPECT TO EMPLOYER SPONSORED GROUP LIFE INSURANCE PROGRAMS
Is Employer-Provided Group or Supplemental Life Insurance a Good Deal?
The first $50,000 of employer-sponsored coverage is a no brainer. If the employer pays for it, it is free.
Will Group Term Insurance be there when you need it most?
Group Term life insurance is a ubiquitous, commoditized benefit designed to cover entire employee populations as inexpensively as possible. By default, many partners in professional service firms, C-Suite executives and highly-compensated physicians find themselves covered under these arrangements. But do they really belong there?
Broad-based employee benefit contracts were never intended to provide all the protection that such individuals need, and in fact, are designed to avoid providing benefits when they are likely to be needed most. Let’s examine some key provisions found in virtually all group life policies:
Group Life as a Multiple of Salary
- Maximum Benefits: the maximum benefits imposed under group term insurance contracts are usually inadequate for professional service firm partners and key executives across other sectors. Typical formulas are two or three times salary with a maximum of $500,000. A simple income replacement needs analysis will generally identify a much higher insurance need for highly compensated individuals. More complex needs, such as estate planning and buy/sell agreements, will call for higher limits as well. Permanent coverage alternatives can be structured to meet the unique needs of partners, executives and other key personnel.
- Age Reductions: virtually all group contracts will reduce benefits due to age. Under the Age Discrimination in Employment Act (ADEA), these reductions must follow certain formulas, with the most common being a simple 50% reduction at age 70. Other plans reduce the benefit by 35% at age 65, with further reductions later on. Individual policies can avoid such decreases, so that key people have full coverage in place when they need it most for their complex insurance requirements.
- Table I Tax: group insurance benefits exceeding $50,000 generate taxable income to the insured. Amounts of this “imputed income” are calculated using monthly insurance rates from IRS Table I. As an example, a partner with $500,000 of coverage at age 65 will pay taxes on additional income of $7,620 annually. Individual, permanent contracts are not subject to Table I taxation. An individual arrangement may be structured to tax premiums currently, which avoid the Table I problem.
- Termination of Coverage: employer-provided group term benefits terminate at retirement, or if hours are reduced below a minimum threshold. This minimum is typically between 20 and 30 hours per week, depending on the contract. Essentially, the key employee is renting the coverage rather than owning it.
Supplemental Coverage
- Supplemental Coverage: some plans allow employees to purchase additional coverage by paying the entire premium for such amounts during their working years. Most supplemental term insurance plans offer premiums in five year “attained age” brackets which become expensive at older ages. As an example, an executive with $500,000 of coverage at age 65 would pay $11,620 annually assuming a monthly rate of $1.86/1,000. On the contrary, many individual policies are structured to stop premium payments at age 65.
- Age Reductions: virtually all term supplemental contracts will reduce benefits due to age. For example, the supplemental coverage may be reduced by 50% at age 70. Individual policies can avoid such decreases, so that key people have full coverage in place when they need it most for their complex insurance requirements.
- Increasing Premiums: the cost per $1,000 of coverage increases with age.
- Premium Duration: premiums are payable until coverage terminates. As mentioned above, individual policies can be structured so that premiums stop at a predetermined age in accordance with retirement planning.
- Cash Value: term coverage does not build cash value, while permanent plans do. This cash equity can be utilized for retirement income or to continue the coverage without premium payments.
While group term coverage serves its purpose, that purpose is not to provide highly compensated employees with the permanent protection they may need to address their complex business and personal needs. Let’s recognize its weaknesses.
If you would like more information on this subject, or have a client who might benefit from a discussion about it, please contact Barry Koslow at bkoslow@mkaplanners.com or (781) 939-6050.
Securities offered through Advisory Group Equity Services, Ltd., Member FINRA/SIPC. 444 Washington Street, Woburn, MA 01801 (781) 933-6100.
This article should not be considered as providing accounting, business, financial, investment, legal, tax, or other professional advice or services. It is not a substitute for such professional advice or services, nor should it be used as the basis for any decisions or actions that may affect your business or you personally. This should only be one part of your research. You should seek authoritative guidance from a qualified accountant or attorney before taking any action.
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