7.2 Group Term Life and AD&D Insurance

Group Term Life and AD&D Insurance

Quick Answer: Group Term Life Insurance (GTLI) is a foundational employee benefit providing pure death benefit protection. Under IRC Section 79, the cost of up to $50,000 of employer-provided coverage is excluded from gross income. Coverage in excess of $50,000 generates taxable imputed income calculated via IRS Table I age-bracket rates per $1,000 of excess coverage, reduced by employee post-tax contributions. If a plan fails Section 79 nondiscrimination testing, key employees lose the $50,000 exclusion and are taxed on the greater of Table I rates or actual carrier cost for 100% of coverage. Accidental Death & Dismemberment (AD&D) pays a Principal Sum (100%) for accidental death or bilateral loss and a Capital Sum (50%) for single dismemberment. Employees leaving the group have a 31-day statutory conversion right to individual permanent life insurance without evidence of insurability.

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1. Group Term Life Insurance (GTLI) & IRC Section 79 Statutory Framework

Group Term Life Insurance provides pure death benefit protection during the period of employment, accumulating no cash surrender value. To qualify for favorable tax treatment under Internal Revenue Code Section 79, a plan must satisfy four statutory requirements:

1. General Death Benefit: It must provide a general death benefit that is excludable from gross income under IRC §101(a).
2. Group of Employees: It must be provided to a group of employees (defined as all employees or a bona fide class based on factors such as union membership, job duties, or compensation).
3. Policy Carried by Employer: The policy must be carried directly or indirectly by the employer (e.g., employer pays any part of the cost or arranges the coverage).
4. Formula Precluding Individual Selection: Benefit amounts must be determined by a formula that precludes individual selection (e.g., flat dollar amounts, uniform salary multiples such as 1x or 2x base pay, or service-graded brackets).

┌─────────────────────────────────────────────────────────────────────────┐
│                     IRC SECTION 79 TAX EXCLUSION RULES                  │
├──────────────────────────┬──────────────────────────────────────────────┤
│ Statutory Exclusion      │ First $50,000 of employer-provided GTLI is   │
│                          │ completely tax-free to the employee          │
├──────────────────────────┼──────────────────────────────────────────────┤
│ Excess Coverage Tax      │ Coverage in excess of $50,000 is subject to  │
│                          │ taxable imputed income reported on Form W-2  │
├──────────────────────────┼──────────────────────────────────────────────┤
│ Calculation Engine       │ IRS Uniform Premium Table I monthly rates    │
├──────────────────────────┼──────────────────────────────────────────────┤
│ Payroll Tax Liability    │ Imputed income is subject to Federal & State │
│                          │ Income Tax and FICA, but EXEMPT from FUTA    │
└──────────────────────────┴──────────────────────────────────────────────┘

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2. Imputed Income Calculation & IRS Table I Mechanics

When employer-provided GTLI coverage exceeds $50,000, the economic value of the excess coverage—known as imputed income—must be calculated and included in the employee's gross taxable income (reported in Box 1 and Box 12 [Code C] of Form W-2).

IRS Table I Monthly Cost Factors

Imputed income is calculated not using the carrier's actual group rate, but using the uniform rates established by the Treasury Department in IRS Table I (Treas. Reg. §1.79-3(d)(2)). The rate is determined by the employee's attained age on the last day of the employee's tax year (December 31):

The Step-by-Step Imputed Income Formula

$\text{Excess Coverage} = \text{Total Employer-Provided GTLI Face Amount} - \$50,000$

$\text{Monthly Imputed Income} = \left( \frac{\text{Excess Coverage}}{\$1,000} \right) \times \text{Table I Rate for Age Bracket}$

$\text{Annual Imputed Income} = (\text{Monthly Imputed Income} \times 12) - \text{Total Annual Employee Post-Tax Contributions}$

Important Offset Rule: Any after-tax contributions made by the employee toward the cost of the basic group life policy are deducted dollar-for-dollar from the total annual Table I calculated cost. (Pre-tax contributions through Section 125 cannot offset Table I imputed income).

Actuarial Calculation Example

An employee is 52 years old as of December 31. The employer provides non-contributory GTLI coverage of $250,000 (2x salary). The employee pays $0 toward the basic coverage.

1. Determine Excess Coverage: $$250,000 - $50,000 = $200,000$
2. Identify Table I Rate: For age bracket 50–54, the rate is $0.23 per $1,000 per month.
3. Calculate Monthly Imputed Value: $($200,000 / $1,000) \times $0.23 = 200 \times $0.23 = $46.00\text{ per month}$.
4. Calculate Annual Taxable Income: $$46.00 \times 12 = $552.00\text{ per year}$.

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3. IRC Section 79 Nondiscrimination Testing

To prevent employers from structuring group life insurance exclusively to benefit executive leadership, IRC §79(d) imposes rigorous nondiscrimination rules.

┌────────────────────────────────────────────────────────────────────────┐
│                     SECTION 79 NONDISCRIMINATION TESTING               │
├────────────────────────────────────────────────────────────────────────┤
│  1. ELIGIBILITY TEST (Must satisfy AT LEAST ONE of the following):     │
│     • 70% of all employees benefit from the plan                       │
│     • At least 85% of participating employees are NON-KEY employees    │
│     • Plan benefits a non-discriminatory classification (IRC §410(b))  │
│     • Plan is part of a non-discriminatory Section 125 cafeteria plan  │
├────────────────────────────────────────────────────────────────────────┤
│  2. BENEFITS TEST:                                                     │
│     • All benefits available to key employees must be available to all │
│       other participating employees on a non-discriminatory basis      │
│     • A uniform multiple of salary (e.g. 2x pay) is NON-DISCRIMINATORY │
└────────────────────────────────────────────────────────────────────────┘

Definition of Key Employee (IRC §416(i))

A Key Employee is defined as any employee who, at any time during the plan year, is:

1. An officer of the employer having annual compensation exceeding the statutory threshold ($220,000+ indexed);
2. A 5% owner of the employer; or
3. A 1% owner of the employer having annual compensation in excess of $150,000.

Consequence of Discriminatory Plan Failure

If a group term life plan fails either the eligibility or benefits test:

• Key Employees: Lose the $50,000 statutory tax exclusion. Key employees must include in gross taxable income the GREATER OF: (1) the actual employer cost per $1,000 of coverage, or (2) the IRS Table I rate for the entire face amount of coverage (from dollar one).
• Non-Key Employees: Maintain their statutory $50,000 tax exclusion and standard Table I imputed income treatment regardless of the plan's failure.

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4. Supplemental Life, AD&D, and Policy Riders

┌────────────────────────────────────────────────────────────────────────┐
│                     GROUP LIFE & AD&D BENEFIT LANDSCAPE                │
├──────────────────────────┬─────────────────────────────────────────────┤
│ Basic GTLI (Core)        │ Employer-paid; 1–2x salary; §79 rules apply │
│ Supplemental Life        │ Employee-paid voluntary; Age-banded rates   │
│ Dependent Life           │ Covers spouse/children; $2k de minimis rule │
│ AD&D Double Indemnity    │ Principal Sum (100%) vs Capital Sum (50%)   │
│ 31-Day Conversion Option │ Guaranteed right to convert to whole life   │
│ Portability Option       │ Right to continue term coverage at grp rates│
└──────────────────────────┴─────────────────────────────────────────────┘

Supplemental (Voluntary) Group Life

Employers frequently offer voluntary, employee-paid supplemental life coverage in increments of salary (e.g., 1x to 5x pay) or fixed amounts (e.g., $10,000 units up to $500,000):

• Guaranteed Issue (GI) Limit: The maximum face amount an employee can purchase without providing medical underwriting (e.g., $200,000) during their initial new-hire enrollment window.
• Evidence of Insurability (EOI): Required for coverage elected above the GI limit or during annual open enrollment if coverage is increased.

Dependent Group Life Insurance & The De Minimis Tax Rule

Employers may offer group life coverage on employee spouses and dependent children:

• IRS Notice 89-110 De Minimis Rule: Employer-provided life insurance on the life of an employee's spouse or dependent child with a face value of $2,000 or less is excludable from the employee's gross income as a de minimis fringe benefit under IRC §132.
• Taxation Over $2,000: If employer-provided dependent life coverage exceeds $2,000 (e.g., $10,000 spousal policy), the entire Table I value of the policy (not just the excess over $2,000) is taxable imputed income to the employee, unless paid with employee after-tax contributions.

Accidental Death & Dismemberment (AD&D) Insurance

AD&D provides specialized financial protection for severe, accidental physical trauma. It is typically offered as a "rider" to basic life or as a standalone policy:

• Principal Sum (100% of Face Amount): Payable upon accidental loss of life or bilateral loss (loss of both hands, both feet, or sight in both eyes; or quadriplegia).
• Capital Sum (typically 50% of Face Amount): Payable for unilateral physical dismemberment (loss of one hand, one foot, or sight in one eye).
• Standard AD&D Exclusions: AD&D policies strictly exclude losses resulting from: suicide or intentional self-inflicted injury, bodily illness or disease, bacterial infection, war or acts of military conflict, participation in a felony, aviation activities as a pilot or crew member, and acute alcohol/drug intoxication.

Conversion Privileges vs. Portability

Living Benefit Riders: Accelerated Death Benefit & Waiver of Premium

• Accelerated Death Benefit (Living Benefit Rider): Under IRC §101(g), permits a terminally ill insured (certified by a physician with a life expectancy of 12 to 24 months or less) to receive an advance payout of 50% to 80% of the life insurance face amount prior to death. Proceeds are received 100% income tax-free.
• Waiver of Premium Rider: If an insured employee becomes totally and permanently disabled prior to a specified age (typically age 60 or 65), all future life insurance premium payments are waived, maintaining the full face value in force throughout the duration of disability.