Why is this Topic Important to Wealth Managers? Discusses group term life insurance policies in general.  Provides a useful tool for client business planning when evaluating group term policy options. Also provides links to additional resources and materials to answer all your group term life insurance questions.

Generally, an employer may provide employees with up to $50,000 of group term life insurance protection each year without cost to employees.[1] However, the exclusion is not available unless the insurance provided under the plan satisfies the definition of “group term life insurance”.

When life insurance provided by an employer meets the following requirements it may qualify as group term life insurance providing special tax exclusion by employees.[2]The life insurance must meet four conditions to meet the definition of group life insurance under the code:

(1) It must provide a general death benefit, excludable from gross income under IRC Section 101(a). Under the regulations, travel insurance and accident and health insurance (including amounts payable under a double indemnity clause rider) do not provide a general death benefit.[3] Employer contributions for such benefits are contributions to a health plan under IRC Section 106 instead of section 79.

(2) It must be provided to a group of employees as compensation for personal services performed as an employee. A group of employees is all employees of an employer, or fewer than all if membership in the group is determined solely on the basis of age, marital status, or factors related to employment such as membership in a union, duties performed, compensation received and length of service.

As a general rule, life insurance provided to a group cannot qualify as group term life insurance for income tax purposes unless, at some time during the calendar year, it is provided to at least 10 full-time employees who are members of the group of employees of the employer.

However, insurance for fewer than 10 employees may also qualify as group term life insurance if: (1) it is provided for all full-time employees; and (2) the amount of protection is computed either as a uniform percentage of compensation or on the basis of coverage brackets established by the insurer under which no bracket exceeds 2½ times the next lower bracket and the lowest bracket is at least 10% of the highest bracket; eligibility and amount of coverage may be based on evidence of insurability but determined solely on the basis of a medical questionnaire completed by the employee and not requiring a physical examination.[4]

(3) The insurance must be provided under a policy carried directly or indirectly by the employer. A policy meets this requirement generally if the employer pays any part of the cost (directly or through another person). The policy can be a master policy or a group of individual policies.

(4) The amount of insurance provided each employee must be computed under a formula that precludes individual selection of such amounts. The formula must be based on factors such as age, years of service, compensation or position. This requirement may be satisfied even if the amount of insurance provided is determined under alternative schedules based on the amount each employee elects to contribute. However, the amount of insurance under each schedule must be computed under a formula that precludes individual selection.

For more information on this topic see AdvisorFYI: Group-Term Life Policy Tax Consequences.

For a detailed discussion on group term life insurance see TaxFacts: Group Term Insurance.

Tomorrow’s blogticle will continue to discuss issues related to the practice of wealth management.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] Treas. Reg. §1.79-1(a).

[3] Treas. Reg. §1.79-1(f)(3).

[4] Treas. Reg. §1.79-1(c).

Barry Flagg continues his popular series, this month discussing the cash value of life insurance as a factor of suitability. The suitability of a permanent life insurance product is influenced by the degree of cash value liquidity throughout the life of the policy. All other factors being equal, the higher the liquid cash value after deduction of cost of insurance charges and policy expenses (including contingent surrender charges), the more suitable the policy.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For in-depth analysis of income taxation of life insurance, see Advisor’s Main Library: D–Gain Or Loss On Surrender Or Sale

The New York Department of Insurance, Office of General Counsel, held on February 25, 2011 that insurance carriers cannot refuse to convert a term policy to a permanent policy on the ground that the policy will be sold on the secondary market. The primary issue in the case was whether the converted policy is a “new” policy that must satisfy anew the insurable interest requirement. Nevertheless, this ruling will not affect all term policies, since many term life insurance policies are not convertible. Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For in-depth analysis of life settlements, see Advisor’s Main Library: B–The Life Settlement Industry.

Last month, we discussed the obvious relevance of pricing competitiveness to overall life insurance product suitability. This month, we discuss the stability of pricing representations which is also a factor of suitability.  After all, pricing that appears competitive at the time of sale/purchase but which cannot be maintained can be worse than a less-competitive product with more stable pricing representations.

For instance, while premiums are often considered the price/cost of a life insurance policy, the premium is not the price/cost of a life insurance policy (unless contractually guaranteed like in term life insurance or guaranteed universal life insurance) any more than the $2,000 contributed to an Individual Retirement Account (IRA) is the cost of the IRA. In both cases, the cost is the sum of what is deducted from the premium/contribution.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of suitability in Advisor’s Journal, see Life Insurance Product Suitability (CC 10-90), Financial Strength and Claims-Paying Ability (CC 10-115) & Cost Competitiveness of Life Insurance (CC 11-11).

The Tax Court recently calculated the fair market value (“FMV”) of life insurance policies distributed by a terminated 419 welfare benefit plan. The FMV of the policies—which must be included in the taxpayers’ income—was determined by the court based on: (1) surrender charges, (2) conditions imposed on the taxpayers by the insurance company, and (3) “paid-up insurance coverage remaining on the policies as of the date of distribution.”  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of policy valuation in Advisor’s Journal, see Tax Courts Holds Employee Taxable for Value of Life Insurance Owned by Welfare-Benefit Plan (CC 11-14).

For in-depth analysis of welfare benefits plans, see Advisor’s Main Library: B—Welfare Benefit Funds.

Although supervising the cost of insurance embedded in life insurance premiums has historically been the domain of state insurance commissioners, the U.S. District Court for the Central District of California has intervened in one recent case, ruling on January 19 that Conseco Life Insurance Co. cannot increase the premiums it charges 50,000 of its existing policyholders.

The premium increase was part of a plan by Conseco to reduce its long-term losses. Rather than post reserves, Conseco looked for a way to reduce its future liabilities by $173 million. They targeted two blocks of universal life policies that had lower than expected lapse rates, using a pricing formula that would explode the cost of insurance charged in the policies’ 21^st year after issuance. Customers who’d held the affected policies longest would have seen their premiums increase in 2010 or 2011.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of another carrier lawsuit in Advisor’s Journal, see Carriers Targeted by Suit Over Losses on Madoff Investments (CC 11-06).

For in-depth analysis of the income taxation of life insurance, see Advisor’s Main Library: A—Definition of “Life Insurance” For Income Tax Purposes.

Cost competitiveness of life insurance policies is an obvious determinant of suitability.  Keeping costs low is critical because every dollar spent on expenses is one less dollar available to purchase more death benefit.  In fact, a recent study by Morningstar revealed that “Low fees are likely to be the best predictor of a mutual fund’s future success,” and the same certainly holds true for life insurance products. 

While different insurers refer to different policy expenses in different ways, all policy expenses in all life insurance policies fall into the following four categories: 1) cost of insurance charges (COIs), 2) fixed administration expenses (FAEs), 3) cash-value-based “wrap fees” (e.g., M&Es), and 4) premium loads.   Each type of policy expense and its role and relevance in pricing and suitability is discussed in the complete analysis at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of life insurance product suitability in Advisor’s Journal, see Life Insurance Product Suitability (CC 10-90) and Financial Strength and Claims-Paying Ability (CC 10-115).

We invite your questions and comments by posting them or by calling the Panel of Experts.