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GROUP TERM LIFE INSURANCE (SEC. 79) PLANS

Group term life insurance is a benefit plan provided by an employer to a group of participating employees. Such plans, also known as Sec. 79 plans, allow the employer a tax deduction for premium payments on behalf of a participant unless the premium amounts cause the reasonable compensation limit to be exceeded (an unlikely event).

If the coverage provided by the plan is nondiscriminatory, the first $50,000 of coverage is provided tax free to all plan participants. If the plan discriminates in favor of key employees with respect to coverage or benefits, the actual premiums paid on behalf of such key employees are taxable as ordinary income. A key employee, as defined under the qualified plan rules, generally includes the shareholder-employees and officers of a closely held corporation. Thus it is important that the plan qualify as nondiscriminatory under Sec. 79 to avoid the adverse tax treatment of shareholder-employees. Otherwise, it is usually better for the employer to adopt an informal bonus plan (discussed below) and permit the shareholder-employees to purchase individual coverage (assuming all selected employees can be underwritten on an individual basis), while permissibly discriminating against other classes of employees.

The taxable amounts of coverage (that is, amounts above $50,000) are taxed according to a rate schedule�the so-called Table I�provided by IRS regulations. Recent tax law changes directed the IRS to develop regulations that increase the Table I cost for coverage over age 64 to appropriate actuarial costs in 5-year age brackets. Previously, the rates were level at age 60 and beyond. The Table I cost for ages above 64 are now determined in 5-year brackets based on the same mortality assumptions used in determining the lower age brackets. Table I rates in 5-year age brackets for ages under 65 remain the same as in the old table. A comparison of the old Table I rates with the new Table I rates is presented in table 12-1.

The effect of these rate changes is to increase the taxable costs of Sec. 79 coverage in excess of $50,000 (or the full amount for key employees if the plan is discriminatory), particularly for the older participants.

Example: Suppose a retired executive has $150,000 of postretirement group term life coverage. Since $100,000 of this coverage is subject to tax, the executive would have to include $1,404 (12 x $1.17 x 100) in income annually at age 64. Under the old Table I rates this annual taxable income would remain constant for the rest of the tax years this coverage remained in force. Under the new rates the annual taxable income incurred by the executive jumps to $2,520 at age 65, and $4,512 at age 70.

TABLE 12-1 Cost per Month per $1,000 TABLE I RATES
5-Year Age Bracket	Old Table	New Table
Under 30 30 to 34 35 to 39 40 to 44 45 to 49 50 to 54 55 to 59 60 to 64 65 to 69 70 and above	$0.08 0.09 0.11 0.17 0.29 0.48 0.75 1.17 1.17 1.17	$0.08 0.09 0.11 0.17 0.29 0.48 0.75 1.17 2.10 3.76

Requirements under Sec. 79

Through a contract held directly or indirectly by the employer, coverage under a Sec. 79 plan must provide the following:

general death benefits excludible from income tax under Sec. 101(a). Thus travel and accident and health (including double-indemnity) policies do not qualify under the group term life rules of Sec. 79.

coverage to a group of employees. Employees must generally be common-law employees. Thus a shareholder can be covered only if he or she is an actual employee of the corporation. A group is either all employees of the employer or less than all employees if the group is determined by reference to factors such as age, marital status, length of employment, employment classification, and/or membership in a union subject to collective bargaining. Such a plan can cover fewer than all employees, which will hold down the plan�s overall cost, as long as the plan complies with the nondiscrimination rules discussed below. A group must also generally include at least 10 employees. Special rules discussed below, however, provide an exception for smaller groups.

insurance protection that precludes individual selection of the amount of coverage. The coverage can be based on formulas related to age, service, job classification, and compensation. For example, a plan that provides a death benefit five times the participant�s annual salary precludes individual selection.

Nondiscrimination Rules Applicable to Sec. 79 Plans
Groups with 10 or More Members

The nondiscrimination requirements focus on both the coverage and the benefits provided by the plan. Under the coverage test the plan must meet one of the following requirements:

cover at least 70 percent of all employees

have no more than 15 percent of the participants from the key employee group

benefit a reasonable classification of participants

For the purpose of this test, the corporation can exclude (1) employees with less than 3 years of service, (2) part-time or seasonal employees, and (3) employees subject to collective bargaining. Generally speaking, it will be difficult for a closely held corporation to exclude any nonkey employees if shareholder-employees and other key employees participate in the plan.

The benefits test requires that the benefits be either a flat amount or a uniform percentage of compensation (for example, 2.5 times current salary). The benefit restrictions permit voluntary purchase of additional coverage by the participant.

Groups with Fewer than 10 Members

The IRS regulations provide more stringent requirements for groups with fewer than 10 members. These groups must meet the following requirements or the favorable tax treatment will be lost:

All full-time employees must be covered (a 6-month waiting period is permissible).

Evidence of insurability may be tested only on the basis of a medical questionnaire.

The benefits must be provided (1) on a uniform percentage of compensation or (2) in brackets where no bracket can be more than 2.5 times the next lowest bracket and the lowest bracket must be at least 10 percent of the highest.

Postretirement Coverage

Although not technically a nondiscrimination rule, the welfare benefit plan rules apply to postretirement group term provided through retired lives reserves (RLR) plans. These rules make it generally infeasible to fund postretirement group term life coverage to retired shareholder-employees in excess of $50,000. This is unfortunate since most of these individuals have substantial estates and desire permanent postretirement coverage of higher face amounts.

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