Tax Treatment of Group Life Insurance

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

In this lesson we will briefly review how the proceeds as well as any premiums or dividends associated with group life insurance policies are taxed by the federal government.

Group Life Insurance Taxation

It's open enrollment time at work again, and Ben noticed that his company offers life insurance for himself and his family. Out of curiosity, he asked the human resources representative if his wife would have to pay taxes on the money if the policy paid out. The Internal Revenue Service refers to these policies available through a person's work as a form of group life insurance. Let's take a look at what the IRS has to say about how taxes work with group life insurance policies.

Employer Carried and Non-Employer Carried Policies

A major determination in whether group life insurance proceeds obtained through an employer policy is whether the employer is considered to directly or indirectly carry the policy. Carrying the policy means that either Ben's company pays some part of the cost of the policy or has arranged the policy structure so that at least one employee subsidizes the cost of insurance for other employees. This second circumstance is also referred to as the straddle rule.

A carried policy represents a taxable benefit for an employee. An exception is made for the first $50,000 of insurance coverage as of 2016. If an employer provides coverage for an employee's spouse or dependents, the cutoff amount that is paid tax free for 2016 is $2,000. If the policies are below these amounts than the beneficiary will not owe taxes on the proceeds. Any amount in excess of the amounts will be subject to the beneficiary's income tax rates. If a policy is not carried by the employer, then there is no tax burden on the proceeds provided the premiums are paid after taxes are already taken out.

Premiums and Dividends

Another matter for Ben to be aware of is the tax treatment of premiums and dividends. If an employee pays for a life insurance policy with money that has already had income taxes paid on it, then the insurance proceeds will be tax-free. On the other hand, if the policy was paid before taxes were assessed then taxes will be due on the proceeds. These periodic costs to maintain the policy are known as premiums.

In some cases, an insurance company may have excess cash reserves because it had lower than expected insurance payouts. In this situation, the company may issue the policy holder a dividend payment. This payment is treated by the IRS as a refund of premiums which have already been paid and are not income. Because of this consideration a dividend is typically not subject to taxes.

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