Group carve-out plans retain favorable tax treatment

by William Fischbach

for the Business Journal

Most employee benefit packages now include group term life insurance, along with group medical coverage. However, these benefits are not often financially favorable for higher paid executives.

Under current federal tax law (Internal Revenue Code Section 79), the first $50,000 of group term life insurance coverage can generally be excluded from the gross income of the covered employees. At the same time, these premiums remain deductible to the employer.

Yet, for high-salaried employees, the incentives may create a disadvantage. For employees whose life benefits exceed the $50,000 cap, there is a much higher taxable cost that must be imputed to the employee.

To avoid this troublesome situation, a new option is available for employers group carve-out.

With an executive carve-out plan, the employer "carves out" an employee or group of employees from the group term life plan.

Typically, the baseline $50,000 group benefit continues to be provided to any "carved-out" employee, since the benefit will still retain the favorable tax treatment for both employee and employer. The balance of the employee's coverage will then be shifted to individual policies that are "superimposed" on the underlying group term plan.

When an employer utilizes a carve-out program, the alternative coverage is generally secured through individual policies, usually cash-value life insurance.

This allows for individual participation in determining benefit need. Clearly, with company group-term plans, the individual employee is prohibited from personal control of benefits and options. Highly compensated executives could be left with grossly inadequate coverage.

In contrast, a carve-out structure allows the executive portability and the opportunity to retain large, full and permanent benefits, even after retirement. Often a retiree, confronting reduced income and loss or reduction of company benefits, is left with only limited and/or expensive conversion options.

Although the post-retirement benefits may not be important to the employee, the positive economics of a carve-out plan are undeniable. It is important to understand that while premiums for large insurance benefits may seem very low through the company's group plan, the stated rates don't tell the whole story.

In the traditional group term plan, once that $50,000 cap is exceeded there is a much higher taxable cost that must be imputed to the employee. This cost is computed monthly using the government's uniform premium table regardless of the actual premium! So, to know the true cost of the present company-paid plan, the tax aspects must be evaluated.

To give a concrete example, let's compare the mandatory cumulative imputed income per $100,000 of excess coverage with actual insurance carrier rates for a 45-year-old, male, non-smoker:

Years IRS Rates Insurance Carrier Rates

5 $1,740 $523

10 $4,620 $1,234

15 $9,120 $2,267

20 $16,140 $3,605

An executive with a benefit in the $250,000 to $500,000 range should simply do the math. The results are a shock, but a group carve-out can be the solution.

Although salaries in excess of $200,000 can no longer be considered in qualified retirement plans or in group term life insurance plans, this restriction does not apply to executive group carve-out plans.

For highly compensated executives, two financial needs can be addressed and solved through a carve-out program.

The primary need is a supplemental and more cost-efficient life insurance benefit. The second need is a supplement for deficiencies in qualified retirement programs.

A carve-out plan takes advantage of:

?insurance carrier rates

?individual benefit selection

?privacy

?policy portability

?no non-discrimination rules

?retirement potential through cash-value-accumulating policies.

Since each policy can be individually tailored, the options for benefit and accumulation structure are virtually unlimited. Any number of split-dollar arrangements can be used.

(For more information regarding split dollar arrangements, please refer to the Springfield Business Journal article in the April 27, 1998, issue, or call BPJ Insurance at 887-3550 for a reprint.)

(William F. Fischbach is an account executive specializing in designing corporate executive benefits for BPJ Insurance.)

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