Is group term life insurance subject to nondiscrimination rules?

Yes, employer-provided group term life insurance (GTLI) is subject to nondiscrimination rules under Section 79 of the Internal Revenue Code. Section 79 allows for the value of up to $50,000 of GTLI coverage on an employee’s life to be excluded from the employee’s gross income. However, certain nondiscrimination requirements must be satisfied in order for all employees to benefit from the $50,000 coverage tax exclusion.

At a high level, the nondiscrimination rules provide that employer-provided GTLI plans cannot discriminate in favor of certain “key employees” with respect to eligibility to participate in the plan or contributions or benefits under the plan. A key employee is defined as an officer with annual compensation in excess of the specified threshold ($200,000 for 2022; $215,000 for 2023), a more-than-5% owner/shareholder, or a more-than-1% owner with compensation in excess of $150,000. Part-time or seasonal employees, full-time employees with fewer than three years of service, and certain employees covered by a collectively bargained agreement may be excluded from testing. Former employees (e.g., retirees) are tested separately from active employees.

GTLI plans that offer all full-time employees the same fixed-dollar or multiple-of-salary benefit will pass the relevant eligibility and benefits nondiscrimination tests (Section 79 provides a safe harbor for these coverage designs). By contrast, GTLI plans that provide benefits exclusively or at a lower cost to key employees, or that provide a higher fixed-dollar or multiple-of-salary benefit to one or more key employees (such as a plan that provides a $200,000 benefit to the company’s CEO but a $100,000 benefit to all other employees), are at risk of being discriminatory. Any GTLI plan that does not cover all benefits-eligible employees at the same fixed-dollar amount or multiple-of-salary formula requires further scrutiny under the nondiscrimination rules.

When a GTLI plan fails a Section 79 nondiscrimination test as to one or more key employees, all key employees lose the benefit of excluding from income tax the value of the first $50,000 of employer-provided coverage. However, non-key employees are not affected by a discriminatory plan design. Employers are encouraged to review the proper taxation of their specific GTLI benefits with their tax advisors.

For further information, download our publication, Group Term Life Insurance: A Guide for Employers.