Plan Tax Considerations

The attractiveness of group carve-out plans is generally enhanced by its tax treatment, which involves:

Premium deductibility
Executive recognition of employer universal life premiums, and
Tax-deferral of universal life cash values


Employer Premiums Deductible

Premiums paid by the employer in a group carve-out plan include both the group term life insurance premium and the universal life insurance policy premium.  Both are income tax deductible to the employer: the first as an employee benefit, and the second as executive compensation.  


 Executive Taxed on Universal Life Premium

Since the employer receives an income tax deduction as compensation for its universal life insurance policy premium payments, that amount is taxable to the executive.  Despite that executive taxability, however, the executive's bonused income resulting from the premium payment may be less than the imputed income under Table I.  (Remember, the Table I cost would apply if the coverage had been provided as group term life insurance.)  


Employee Cash Values Tax-Deferred

The universal life insurance policy's taxation is the same as that afforded any personally purchased life insurance policy.  Specifically, the growth on cash value is tax-deferred, and policy withdrawals are subject to FIFO tax treatment.

For an employee in a high tax bracket, the combination of these tax benefits may make a substantial difference in the amount of after-tax income received.  Consider the accumulation benefits of simple tax-deferral shown in the table below.  If an investor in a 33 percent tax bracket placed $5,000 each year into a tax-deferred account and $5,000 in a currently-taxable account simultaneously, the results would be substantial as the years wore on.

By the end of 10 years, the investor would have $9,024 more in the tax-deferred account.  Only five years later, the difference would have grown an additional $15,000 and would stand at $24,087.  It is not until 20 years and later that we see the very large differences: $51,806 after 20 years, $175,548 after 30 years, and almost a half-million dollars difference after 40 years.  

It could certainly be argued, however, that the funds in the tax-deferred account would need to be exposed to taxation before the investor could use them.  While conceding that point, the difference may still be substantial.  If the investor withdrew all of his or her funds from the tax-deferred account at the end of 20 years -- not normally the most tax-wise approach -- he or she would still be more than $12,000 ahead in the tax-deferred investment.

When we factor into the equation that the executive can access the tax-deferred universal life insurance cash values on a tax-free basis through withdrawals to basis followed by policy loans, the difference in results is even greater.


BENEFITS OF TAX-DEFERRAL
$5,000 Annually; 33% Tax Bracket
End Of Year
 Tax-Deferred Accumulation at 7%
 Currently Taxable Accumulation at 7%
    Difference
1
 $       5,350
 $     5,235
$ 115
2
11,075
10,714
361
3
17,200
16,452
748
4
23,754
22,458
1,296
5
30,766
28,745
2,021
10
73,918
64,894
9,024
15
134,440
110,353
24,087
20
219,326
167,520
51,806
30
505,365
329,817
175,548
40
1,068,048
586,478
481,569