Your Guide To Navigating Employee Benefits: Life Insurance

May 31st, 2024 by Blake Pinyan

Life insurance is a crucial employee benefit offered by many large employers. Before diving into the details, it’s important to understand what insurance is. In its simplest form, insurance is a contract between an individual and an organization where the individual agrees to pay money in exchange for a payout from the organization in the event of a specific loss, damage, illness, disability, or death. People pay premiums for a life insurance policy to receive a payout in case of death, helping to alleviate the financial burden that such a loss can cause due to the stoppage of income. The death benefit is generally paid out tax-free to the designated beneficiary (or beneficiaries) on the policy.

In this article, I will explore why life insurance is needed and who needs it, how premiums are calculated, how employers typically offer it, and what you should consider when making your election.

The Need for Life Insurance

Why Life Insurance is Needed

Life insurance is essential for individuals whose dependents rely on their income. When a person passes away, their paycheck ceases, leaving their dependents without financial support. While some employers provide a post-mortem benefit, it is usually a one-time payment and not sufficient to replace ongoing income.

When considering life insurance, it’s important to think in terms of multiple years rather than just annually. For instance, a 45-year-old earning $150,000 and supporting a family might plan to work for another 20 years, equating to over $3,000,000 in potential earnings. Life insurance is crucial for such individuals to ensure that their family does not face financial hardship in the event of their sudden death as it can lead to millions of dollars in future earnings not collected.

The need for life insurance varies based on individual circumstances, including earnings, dependents, and life stage.

Who Needs It Less

• Single Individuals: Those with no spouse, children, siblings, or other dependents who rely on their income alone have less need for life insurance. While it is beneficial to their potential heirs, it is not as critical for them.
• Dual-Income Couples Without Kids: If both spouses are financially independent and do not rely on each other’s income, the need for life insurance is reduced.
• Retirees with No Dependents: Retirees who no longer have future earnings to insure and have financially independent children typically do not need substantial life insurance. However, there are exceptions, such as retirees with dependents or those that rely on pension income.

Who Needs It More

• Families with Young Children: Families where the primary earner supports the household financially need significant life insurance coverage. The loss of this income could be devastating, especially with a long-time horizon to retirement.
• Single-Income Couples: Married couples where one spouse relies on the other’s income also need life insurance to protect against the loss of that income.
• Retirees with Dependents: Retirees with pensions that do not offer a full survivor benefit need life insurance to protect against the loss of pension income. Similarly, retirees with single-life annuities or social security benefits that decrease upon the death of one spouse may need life insurance to offset the income loss for their spouse and/or dependents.

Special Considerations for Retirees

Obtaining life insurance in retirement can be challenging due to health issues or high premiums. Consequently, few retirees have life insurance policies unless they have fixed-premium policies purchased outside of employer plans that continue beyond retirement.

How Premiums Are Calculated

Life insurance premiums are primarily determined by the age and health status of the insured. Younger and healthier individuals typically pay lower premiums, while older individuals or those with health issues face higher costs. Insurance carriers assess the insured’s health through a series of questions and requests for medical records. Those with a history of health problems may receive higher quotes or be denied coverage altogether, as insurers seek to minimize risk. Consequently, premiums are significantly higher for older individuals due to the increased likelihood of a claim.

Carriers also evaluate lifestyle habits, such as smoking, and categorize applicants into different health classes, such as preferred non-smoker or non-preferred. Smokers generally face higher premiums due to the associated health risks.

Additionally, premiums vary by gender. Women generally pay lower premiums than men because they tend to live longer, resulting in a lower risk of payout for insurers. Men, having a higher risk of mortality, are charged higher premiums for life insurance policies.

How Employers Offer Life Insurance

Many larger employers offer life insurance benefits to their employees, typically through two main options: Basic Life Insurance and Supplemental Life Insurance.

Basic Life Insurance

Basic Life Insurance often comes at no cost to the employee. Employers typically present this benefit as a fixed amount, such as $50,000, or as a multiple of the employee’s base salary, such as 1x or 2x. For example, an employee with a base salary of $100,000 and a Basic Life Insurance policy at 2x salary would have $200,000 in death benefit coverage provided by the employer. This coverage does not usually include bonuses or other forms of compensation.

Supplemental Life Insurance

If Basic Life Insurance is offered, employers often provide the option to purchase Supplemental Life Insurance. This additional coverage allows employees to increase their death benefit beyond the basic level.

Key Points About Supplemental Life Insurance:

1. Maximum Coverage Limits: There is usually a cap on the amount of supplemental life insurance an employee can purchase, often defined as a specific dollar amount (e.g., $500,000) or a multiple of the base salary (e.g., up to 5x salary).
2. Coverage for Dependents: Employees can often buy life insurance for their spouses and children, though the maximum limits for dependents are typically lower than for the employee.
3. Evidence of Insurability: Employees should be aware of the guaranteed amount of coverage available without proof of good health, known as the “guaranteed issue” amount. This amount is available without medical underwriting, but it might only be accessible to new hires for a limited time. If additional coverage is desired beyond the guaranteed amount, medical underwriting is generally required. This could involve health questionnaires, medical tests, and/or providing medical records.

Accidental Death & Dismemberment (AD&D) Insurance

Employers that offer traditional life insurance often include Accidental Death & Dismemberment (AD&D) Insurance as well. AD&D coverage functions similarly to traditional life insurance but with stricter payout criteria. It only pays benefits for deaths or injuries that meet specific conditions, such as accidental deaths. Consequently, AD&D policies have lower payout frequencies than traditional life insurance due to the narrow and unique scope of covered events.

Key Points About AD&D Insurance:

1. Basic and Supplemental Coverage: Like traditional life insurance, AD&D insurance includes both basic and supplemental options. Basic AD&D coverage is often covered by the employer if basic life insurance is provided.
2. Additional Costs for Supplemental AD&D: Employees can purchase additional AD&D coverage, though its necessity depends on individual lifestyle and activities.

Understanding the details of both Basic and Supplemental Life Insurance, along with AD&D options, is important for employees to make informed decisions that align with their financial plans and personal circumstances.

Life Insurance Considerations

When deciding on life insurance, several key factors should be considered:

Cost

Supplemental life insurance through an employer is generally not free, but it is usually affordable. Premiums are deducted from the employee’s paycheck and vary based on the death benefit amount and the number of lives covered. For instance, a single individual with a small supplemental death benefit will pay less than someone with the highest death benefit covering him/herself, his spouse, and his children. In general, higher death benefits and more covered lives result in greater costs.

From a tax perspective, employees do not pay taxes on the first $50,000 of employer-provided life insurance. However, any amount exceeding $50,000 is included in the employee’s taxable wages, as reported on their W-2 form.

While supplemental life insurance costs money, it is typically cheaper than obtaining an individual policy due to group rates offered by employers. Group rates are based on the overall health of the group rather than the individual.

Term

Employer-provided life insurance is typically offered as group-term insurance, which covers a group of employees for the duration of their employment. Coverage continues as long as the employee remains with the company. Upon retirement or leaving the company, coverage generally ceases unless the employee opts for continuation, which can be costly.

Employees should be aware that their coverage will end upon retirement or departure unless continued. Therefore, obtaining a new policy through a new employer or an individual plan may be prudent if life insurance is needed.

The Need

When considering life insurance, it is critical to determine the appropriate amount of death benefit. This varies based on individual or family financial circumstances and other available resources. A life insurance needs analysis can help determine the necessary coverage by considering factors such as income, expenses, financial goals, assets, liabilities, existing life insurance, and additional income sources.

Generally, it is advisable to purchase a higher death benefit for the higher earner in the family, as their income typically covers more expenses. Higher earners usually need more coverage due to higher expenses, while lower earners with fewer expenses may not need as high a death benefit.

Employers often cap the maximum death benefit coverage that can be purchased, which may not align with the employee’s needs. For instance, if an analysis determines an employee needs $2 million in coverage but the employer only offers up to $1 million, the employee may need to explore additional coverage from external providers.

It is essential to complete a life insurance needs analysis to determine the appropriate amount of coverage for a financial plan, ensuring adequate protection for the family in the event of the insured’s passing.

Conclusion

When considering the employee benefit of Life Insurance, it is essential for employees to approach the decision thoughtfully. They should carefully consider the costs, whether to opt for supplemental coverage, whom to cover, the necessary amount of life insurance, and whether additional coverage outside their employer is warranted to provide further protection for their family.

At Anchor Bay, we guide our clients through the complexities of Life Insurance. We conduct thorough analyses of their life insurance needs to ensure they have adequate coverage, alleviating concerns about financial struggles for their loved ones in the event of an unforeseen tragedy.

Life is unpredictable, but with proper planning, you can mitigate some of the uncertainties. While Life Insurance cannot erase the pain of losing a loved one, it can certainly ease the financial burden during a difficult time.