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Pre-Tax Life Insurance Premiums


Guest akwallace
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Guest akwallace

What are the cafeteria plan rules for including life insurance premiums?

I read in a previous post that an employer can only include the premiums for up to $50,000 of employee paid life insurance in a cafeteria plan - is that correct? What about spousal life premiums - are the rules any different.

Thanks!

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Yes, the $50,000 cap is correct. Anything above that cannot be offered through the 125 plan, so premiums should be post-tax. Concerning spouse/dependent life, this cannot be offered through a 125 plan. Premiums should be post-tax, and death benefits will be tax-free.

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Guest akwallace

Is there no way at all around the $50,000 pre-tax limit? Any way that a cafeteria plan could be written to include over $50,000?

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Guest Matt J

Maybe I misunderstand the discussion, but can't employee contributions be pre-tax no matter the volume? Imputed Income would then apply to any volume over $50,000.

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Yes, actually you are correct, and I should have pointed that out to akwallace, as well.

In the real world, I think this is not a useful option. It would mean that the death benefit over $50,000 would be taxable to the beneficiary. I can think of almost no reason that a person would want to take relatively miniscule pre-tax payroll deductions and realize such small upfront tax savings and be willing to allow a potentially huge death benefit to go to an heir as a taxable sum.

Even if a plan had been mistakenly taking pre-tax deductions for amounts over $50,000, I would correct the plan before letting it go status quo.

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Guest Matt J

My understanding is that the Imputed Income paid (reported on the W-2 as taxable income) is a far better solution than taking the benefit deduction after tax. The imputed income paid will not be more than the income taxes paid on an after tax deduction.

The death benefit would then be non-taxable because the employee has paid tax on the amount over $50,000 up front.

At least that is how my company's policy is written as well as most of the companies we design and administer in the cafeteria plan setting.

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I think that would be correct if the insurance over $50,000 is provided by the employer. Imputed income is calculated by taking the amount over $50K, multiplying that by the rate per $1000, then subtracting the amount of premium paid (after-tax, I've always thought) by the employee. If the employee pays nothing, then the entire amount over $50K is imputed income. If the employee pays for the insurance over $50K based on his/her age bracket and the dollar amount over $50K, then imputed income is brought down to nothing. In essence, we outlined the situation of a person paying for insurance over $50K with after-tax dollars, and the death benefit is tax-free.

Imputed income takes premium amounts that an employee does not pay for life over $50K and forces it to be, effectively, a taxable premium reimbursement to the employee, thereby maintaining the tax-free death benefit. I think Notice 89-110 supports this.

The more I look into this, I don't see that any pre-tax deductions can be taken for life insurance over $50K. I was equating life insurance with LTD, for instance, where pre-tax deductions yield taxable benefits and post-tax deductions yield tax-free benefits. I now don't see how this can apply to life over $50K.

I'm going back to my original statement that pre-tax deductions can never be taken for life insurance over $50K. Can anyone think of something contrary to this? Am I missing something?

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Guest Matt J

Here is my specific situation:

My current policy offered through my employer is 1x Base Annual Earnings. This is company provided. I then have the option to purchase additional coverage. I elected an additional $200,000. Of this I pay imputed income on the "total" amount over $50,000. This is added into my pay as taxable income. The Plan Summary states that death benefits are received as non-taxable.

I guess I have never seen anything to state this is not the correct way to handle the taxation??

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Mattj..

You say that you "have the opition to purchase" and did elect $200,000 over the $50,000 that is "company provided". If this is the case then there can be no imputed income, because you paid the premium. Imputed premium only arises when someone else (the employer) pays the premium for you.

In any case what you outlined does provide a tax free death benefit provided the premium was not paid on a pre-tax basis for the amount over the $50,000.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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So, if you are willing to have the amount over $50K go to your heirs as a taxable sum, then can you legally force your employer to take the deductions pre-tax? Again, I can see no practical, real-world reason to do this. But can it be done? I don't believe I've ever seen it before.

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Guest Matt J

The way we design cafeteria plans and how our own Life plan works is that the policy is technically purchased by the Employer. I, the Employee, direct my Employer to purchase my policy. My deductions are pre-tax, but the Employer technically pays the premium and charges me via payroll deductions. For amounts over $50,000, I have to pay imputed income. The death benefit is then non-taxable because I have, in essence, paid taxes through the imputed income amounts. I pay lower tax rates with imputed income than it would ever amount to through income taxes.

I think we may be discussing different items. The policies I am talking about are Group plans offered through an Employer who is directed to purchase a policy and pay for it. The Employer then recoups costs above the provided amount via my payroll deductions.

I think your argument is accurate in the non-group setting. I also think you would have issues with any company provided amount that will be over $50,000. How would you handle a 1x Salary company provided benefit that volume exceeds $50,000?

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I am also talking about group policies. The way I have always seen this done is this: Say an employee makes $30,000. The employer provides 2X salary, and supplemental is offered to the employee. In this case, 2X is $60K. The employee gets the $50 from the employer no problem, then $10K ($60K-$50$) is imputed income. This would be 10 times the life rate per thousand for the employee. Whatever this comes out to is imputed income. As far as the supplemental coverage over $60K, this is paid through after-tax dollars, and there is no imputed income. With imputed income, you are not paying taxes on the death benefit. You are paying taxes on the premium payment which is being provided by your employer over and above the allowable $50K. If Section 125 did not allow for any life insurance to be a non-taxable benefit, then all payroll deductions would have to be post-tax. Since 125 allows for $50K, then only anything above that must have its premiums taxed. That's why when an employer provides anything over $50K, the premium that relates to the amount over $50K must be reported as imputed income.

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I have more. This one has really got me thinking. To answer your specific question, if a 1X salary is provided by the employer and this amount exceeds $50K, then the employee has to pay imputed income on the amount that exceeds $50K.

I know what you are saying concerning pre-tax payroll deductions and how they effectively turn into employer payments. Say you take pre-tax payroll deductions for premiums for GTL over $50K then pay imputed income. If you are saying that these pre-tax payroll deductions turn into employer contributions, then:

Imputed income = (Dealth benefit-$50K) * rate per thousand – employee payments

Since employee payments in your argument are zero, then imputed income equals the premium for the amount over $50K times the rate per thousand. This is the premium. You have just turned it into post-tax dollars, again. You would have ended up in the same position if you had just paid the premium post-tax, rather than pre-taxing it and then paying imputed income. It’s exactly the same. Paying imputed income is not less than making post-tax premium payments.

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