CONTINUATION OF GROUP TERM INSURANCE

Most postretirement life insurance coverage consists of the continuation of group term insurance. This requires the employer to make important decisions regarding the amount of coverage to be continued and the method of paying for the continued coverage. Although the full amount of coverage prior to retirement may be continued, the high cost of group term life insurance coverage for older employees frequently results in a reduction in the amount of coverage. In some cases, employees are given a flat amount of coverage (such as $2,000 or $5,000); in other cases, employees are given a percentage (such as 50 percent) of the amount of coverage they had on the date of retirement.

Current Revenue Funding
The cost of providing postretirement life insurance is usually paid from current revenue, with each periodic premium the insurance company receives based on the lives of all employees covered, both active and retired. Because retired employees have no salaries or wages from which payroll deductions can be made, most postretirement life insurance coverage is noncontributory.

The tax implications of providing postretirement group term insurance on a current-revenue basis are the same for both the employer and the employee.

Retired-Lives Reserve To Continue Coverage
In the late 1970s and early 1980s, increasing interest was shown in prefunding the cost of postretirement group term insurance coverage through retired-lives-reserve arrangements. Much of this interest stemmed from Internal Revenue Service Section 79 regulations that made previously popular products less attractive. The concept was not new; retired-lives reserves, while not extensively used prior to that time, had been in existence for many years, primarily for very large employers. However, the trend in the 1970s was to establish them for smaller employers because the tax laws allowed the plans to be designed so that they often provided significant benefits to the firm's owners or key employees. Because the Tax Reform Act of 1984 imposed more stringent requirements on retired-lives reserves and because of the availability of newer products for postretirement coverage, there is little interest in establishing new plans. Nevertheless, plans still exist, primarily in heavily unionized industries and usually for employers with 2,000 to 5,000 employees. In addition, other plans still exist for employees and retirees previously covered under them, but other arrangements are used for newer employees.

A retired-lives reserve is best defined as a fund established during employees' working years to pay all or a part of the cost of their group term insurance after retirement. The fund may be established and maintained through a trust or with an insurance company. If properly designed, a retired lives reserve (1) will enable an employer to make currently tax-deductible contributions to the fund during employees' working years and (2) will not result in any taxable income to employees before retirement. However, current deductions may be taken only for prefunding coverage that will be received tax free by retired employees under Section 79. This amount is generally $50,000 but may be higher for certain employees, subject to a grandfather clause. In addition, contributions on behalf of key employees cannot be deducted if the plan is discriminatory under Section 79.

At retirement, the assets of the fund can be used to pay the cost of maintaining the postretirement coverage. If assets are withdrawn from a trust, there is the possibility of the fund's being inadequate in the long run because of higher premiums and/or shorter life expectancies than anticipated. However, insurance company products typically assume the adverse mortality risk and guarantee that the fund will be adequate to maintain the promised benefits as long as the prescribed contributions have been deposited with the insurer.

As long as an employee has no rights in a retired-lives reserve except to receive postretirement group term insurance coverage until his or her death, the employee will incur no income taxation as a result of either employer contributions to the reserve or investment earnings on the reserve. In addition, up to $50,000 can be received income-tax free by beneficiaries.

In those instances where death benefits are paid directly from trust assets, the tax consequences to the employee are the same as if death benefits were provided through group term insurance contracts, except that death proceeds will represent taxable income to the beneficiary