Not So Free Life Insurance

After a recent job change, I get new pay slips that contain cryptic entries about pay deductions. One of these entries is related to life insurance even though my employer gives me this insurance for free. Unfortunately, life insurance is considered a taxable benefit and I pay almost as much in income taxes as it would cost to buy the insurance on my own. For younger employees (like I was the last time I looked at this issue), free life insurance can be more expensive than buying it on your own.

In most group plans, life insurance premiums are based on the amount of insurance, but not the insured’s age. The plan assumes some average premium reflecting the age distribution of employees. This means that young people have an artificially high value assigned to their taxable life insurance benefit.

Employees end up paying tax on this benefit at their marginal tax rates. For young employees, this can mean paying more for the insurance than it would cost them to purchase it privately from an insurance company.

However, I’m not that young any more. Even so, the value assigned to my life insurance is more than double what I would pay privately. After factoring in my marginal tax rate, the amount I pay in taxes is only $1.47 per year less than I would pay with a private plan. So much for free life insurance.

Once you take into account the fact that this insurance would go away if I leave my employer, I’d be better off buying my own life insurance. Life insurance through group plans is usually transferrable, but the new premium goes way up unless you agree to a health check. However, if you leave your job for health reasons, this won’t help much.

Comments

  1. geneMay 18, 2010 at 11:55 AM

    I recall you had a challenging talk with your previous (or current?) employer about trying to refuse the free life insurance they were providing.

    It's more subtle than refusing the free trial the credit card companies give for credit card insurance (what a rip off), but still, most of the time "free" doesn't mean free.

    ReplyDelete
  2. Michael JamesMay 18, 2010 at 1:05 PM

    @Gene: It was a previous employer that wouldn't let me decline the life insurance. I'm older and wiser now. I pick my battles more carefully. I've decided that my present employer's free life insurance involves little enough money that I'm not going to worry about it. I'll just explain this to some younger colleagues and see if they care enough to complain.

    ReplyDelete
  3. Brian Poncelet,CFPMay 23, 2010 at 9:03 AM

    In general you are better to get your own life insurance. Usually there is limits to how much you can get.

    I put together a calculator person A (who has more money no life insurance) and person B less money but permanent life insurance.

    Person B will pay less taxes spend more money in retirement.

    http://www.rightinsurance.ca/tools.html


    cheers,

    Brian

    ReplyDelete
  4. Michael JamesMay 23, 2010 at 9:19 AM

    @Brian: I took a look at your table comparing Person A (with no life insurance) and Person B (with permanent life insurance). At age 85, person A still has $2 million, but person B's assets are gone. Further, person B must have paid a huge amount in premiums over a lifetime to fully pay-up $2 million of permanent insurance. Your comparison is highly biased.

    ReplyDelete

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