GROUP CARVE-OUT TAX ISSUES

Deductible Premiums

The premium paid by the employer for the life insurance provided under both the base group term life insurance policy and the universal life insurance policy is income tax-deductible: the group insurance premium is deductible as an employee benefit, and the universal life insurance premium the employer pays is deductible as compensation to the policyowner executive.  The premium the employer pays for the universal life policy is considered a bonus to the executive and is therefore deductible to the employer. However, as a bonus, it is taxable to the executive.


Taxable Income Generally Less than Table I Costs

Although the premium is taxable to the executive as income, it is expected that the taxable income to the executive would be less than the Table I costs that would have been incurred if the group carve-out plan had not been implemented.

From the earlier example of the 45-year-old executive with the $500,000 group carve-out universal life insurance policy, the $2,580 premiums the employer paid over the 20-year period result in additional taxable income to the executive of $51,600.

If, instead, the same additional $500,000 had been provided through group term life insurance, the Table I cost would have resulted in an additional $80,700 of imputed taxable income to the executive. In this case, the group carve-out plan saved the executive the income tax due on $29,100 the difference between the employer-paid universal life insurance premiums and the Table I costs.   




Premium is a Bonus for the Executive

Because the premium the employer pays for the universal life insurance policy issued under the group carve-out plan is bonused to the executive, the executive is required to include the bonus in income for tax purposes. The tax treatment of the life insurance policy is the same as the treatment afforded any personally purchased life insurance policy-tax-deferred cash value and FIFO withdrawal treatment.


Tax Deferred Savings for the Executive

For the high-income executive, tax deferral-especially when coupled with FIFO tax treatment of withdrawals is highly desirable. The benefits of tax deferral are readily apparent. Let's briefly examine the difference in accumulation between tax-deferred savings and currently taxable savings. Consider the illustration shown here, which assumes that $6,000 is saved annually by an executive in a 36 percent marginal income tax bracket. As we can see, the difference between tax-deferred savings and currently taxable savings is an additional $73,108 at the end of 20 years at a 7.55 percent assumed interest rate.



Gross-Up Bonus

Despite the fact that the executive's tax liability is lower under a group carve-out plan than under group term life, some executives may still object to the taxable income such a plan creates.

If this is the case, the employer may choose to pay a double bonus, also known as a gross-up bonus. Under the double bonus approach, the employer pays bonus of the universal life insurance policy premium to the executive and then an additional amount equal to the tax liability on the bonus. The result of this double bonus is that the executive's after-tax cost is reduced to zero.