What is imputed income from life insurance?
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When you are planning to buy an important product life insurance, you need to consider everything from A to Z. Today you may only need a small amount of coverage but when you reach a new stage of your life your need for coverage will change.
Today you might only be able to afford a small term insurance plan through your work, but in the future a permanent plan may be more suitable for you so that you can give your heirs something to pay estate taxes with.
Buying life insurance involves more than just budgeting and selecting the most affordable plan, it also involves doing your homework so that you are aware of how the type of plan you choose can affect your current financial situation.
When you are buying life insurance, you are so overwhelmed by all of the types of insurance that you can choose from that you fail to ask questions pertaining to what will happen around tax time after a policy is purchased.
Failing to ask about the financial implications of buying specific types of group life insurance can have its consequences when you are filing your personal taxes.
Little do you know that a life insurance portfolio that includes group life insurance could actually raise your tax liabilities and put you in a higher income bracket.
This is referred to as imputed income, and a majority of people who carry group life insurance have no clue that imputed income even exists until they file their taxes and they are asked to include the imputed income from their group life plans.
If you are not familiar with imputed income and you would like to know more about this and other characteristics of group life, read this consumer-friendly guide and get informed today so that you are prepared for tax season.
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What is imputed income from life insurance?
Simply put, imputed income is a term constructed by the Internal Revenue Service to describe the taxable value of a group life insurance policy that a taxpayer holds.
The reason it is called imputed income is because the IRS sees this employer benefit as a form of income because you are not paying the full value of the policy with after-tax dollars out of your own pocket.
Because the premiums for group life insurance are paid for with pre-tax money during each pay period, you are taxed as if you were receiving cash in the amount that is equal to the value of the coverage provided.
The value is based on the amount of coverage that exceeds the exempt threshold. Anything above the exempt limit will be consider employer provided and will be taxed as imputed income.
What is the imputed income exclusion?
In order to have tax implications for your group term life insurance, you first must carry a group life insurance plan that is employer-sponsored.
If you have an employer provided plan that is carried directly or indirectly by the employer, there will be tax consequences as long as the total amount of the coverage exceeds $50,000. Section 79 of the IRC says that any coverage that is less than $50,000 is excluded and does not need to be counted as imputed income.
What type of plans are taxable?
Not all types of life insurance plans are deemed to be taxable.
This is something that you need to understand as you are weighing your options and searching for a life insurance plan to add to your financial portfolio.
According to the IRS, there is a taxable fringe benefit only when the policy that you carry is provided directly or indirectly by the employer.
This means that when your employer pays for any part of your premiums or when the employer arranges the payments through subsidization, the value of the policy is taxable.
If the policy that you carry is not paid for by your employer or subsidized in any way as a group plan, you are paying all of the costs.
When you are paying the entire cost for insurance there are no tax consequences and there is no imputed income.
This is referred to as individual insurance. When you have an individual insurance plan, you do not just pay the full premiums, you also own your own plan and have the freedom to choose who you buy coverage through and the type and limit of insurance that you want.
What happens if your coverage exceeds $50,000?
Anything above the $50,000 amount can be included in income and is subject to social security and medicare taxes.
Not the entire amount of coverage is considered taxable. Instead, the IRS has developed an imputed income table that shows the taxable income of group term coverage. The amount of income to be included will be calculated using an IRS Premium Table or a calculator.
How to Calculate Imputed Income By Hand
You can find calculators online, but if you would like to do the calculations on your own it is fairly simple.
First, you will need your death benefit. Subtract $50,000 from your group life benefit. Then, you will divide that number by 1,000.
The result will then need to be multiplied by your IRS Table I rate. This will be the monthly amount that you pay.
When are you taxed for imputed income?
When you carry group life insurance, the premiums that you pay will come out of each paycheck with pre-tax dollars. These pre-tax dollars may also be used to pay for any taxable imputed income that is calculated when the check is printed.
If you have a large employer-sponsored life insurance plan that exceeds the $50,000 threshold, there is a good chance that there will be what is referred to as a tax wash.
What this means, simply put, is that the money that you save by purchasing the group life coverage at a lower rate is washed because of the amount of taxes you pay on the imputed income.
Why to Buy Individual Life Insurance
There are advantages to buying group life insurance if you stick below the $50,000 threshold. Not only is group life a great choice when you have pre-existing conditions, it is a great option if you want a small amount of protection for your family without having to go through underwriting.
While group term insurance has its advantages, it should never be your sole insurance policy. Group policies are only priced better than individual insurance if you are not subject to the imputed income tax. If you are, you are better off opting for a policy that you own yourself.
A major drawback of group life that many do not consider is that it is a policy that is not just provided by the employer, it is owned by the employer as well.
If you leave the company for a new company, you are laid off, or you retire, this is a benefit you will no longer receive. The company also has the right to choose when they do not want to offer life insurance benefits and can cancel your policy without notice.
If they find a better deal, they can work with a new and less reputable insurer and you have no say in the transaction. It is also common for your group life premiums to go up as you age.
If you select the right individual life insurance plan you will have much more peace of mind.
The plan may seem to be more expensive, but if you are in good health and you are young, you can find a very affordable term life plan that will not be considered a taxable fringe benefit.
You do not have to worry about changing employers because you will have a policy that will not be affected.
You will also have a lot more flexibility if you carry your own individual policy because you can select the limit that you want and the policy type as well.
It may seem as if you are paying a higher premium at face value, but after reviewing the cost of the taxation in each paycheck, you will find that it is in your best interest to carry your own plan.
Stick with a $50,000 face value plan through your employer and buy the rest of your coverage through a carrier that you can trust.
There is no denying the fact that buying group life insurance is convenient. Your employer offers you plans, you check a box, and the policy is activated and paid for out of your check.
While it is convenient, many do not look deep enough into the terms and conditions to find out that they are paying taxes on the value of the plans because they are defined as imputed income. Price the cost of the taxes yourself and see how much your group life insurance is really costing you.
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