Group Carve-out

An employer currently gives its senior executives very large amounts of employer-paid GROUP TERM life insurance. It wants to stop doing that and instead provide each executive with individually owned permanent coverage, partly because the excess employer-paid group coverage generates reportable income for them. The design being described is:

1. A.A conversion of the master policyConversion is a right an individual exercises on leaving the group. The executives here are still employed.
2. B.A contributory group planContributory simply means employees pay part of the group premium. It does not move anyone to individually owned coverage.
3. C.A blanket life arrangementBlanket coverage insures an ever-changing class of people with no individual selection, which is the opposite of what is described here.
4. D.A group carve-outCorrect. Selected executives are carved out of the group plan and covered individually instead.

Why: A group carve-out removes selected employees, usually executives, from the employer-paid group term plan above a chosen level, and replaces that coverage with individually owned permanent insurance. Beyond the tax motive, the executive ends up owning portable, permanent coverage instead of employer-controlled term. The clues are the executive selection, the move to individually owned permanent coverage, and the reportable-income motive. Review: business uses of life insurance.

Coppermere Freight keeps a modest amount of group term life on all employees, but removes its five executives from amounts above that base level and replaces the excess with individually owned permanent policies the executives keep if they leave. The company's stated aims are to stop reporting large imputed income on the executives and to give them portable, permanent coverage. What is this arrangement, and what is the tax result for the executives?

1. A.A group CARVE-OUT: the executives are taken out of the group plan above a base amount and covered individually, so employer dollars applied to their coverage become taxable compensation rather than Section 79 imputed income on the excess.Correct. The carve-out swaps escalating Table I imputed income for ordinary taxable compensation and hands the executives portable, permanent, individually owned coverage.
2. B.A nondiscriminatory Section 79 plan under which the executives report no income at all.Section 79 shelters only a limited amount of employer-paid group term coverage, and even a nondiscriminatory plan produces imputed income on the excess. No arrangement here makes the executives' benefit tax-free.
3. C.A split-dollar arrangement, because the employer and the employee share the premium.Split dollar divides premium, cash value and death benefit between employer and employee under a written agreement, with the employer retaining an interest. Here the executives own their policies outright and the employer retains nothing.
4. D.Group conversion, because the executives are moving from group coverage to individual coverage.Conversion is a right an individual member exercises when group coverage terminates, on the insurer's conversion terms. This is an employer-designed benefit for a selected class while they are still employed.

Why: This is a group CARVE-OUT. A selected class is removed from the group term plan above a base amount and covered instead by individual contracts. Because the employees own those individual policies, employer dollars applied to them are ordinary taxable compensation rather than Section 79 imputed income on the excess coverage. The executives gain portability and permanent cash value, and the employer sidesteps the escalating Table I cost that makes large group term coverage expensive for older, highly paid employees.