253 / If an employer provides life insurance under a group term life insurance policy, what are the advantages of a group carve-out plan to employees and to the employer?

Under a group carve-out plan, an employer removes or carves-out one or more highly-compensated employees from the life insurance coverage provided by a group term life insurance policy under IRC Section 79. The carved-out employees are provided life insurance coverage through individual policies. Low term insurance rates on individual policies and lower minimum premiums on permanent policies contribute to the popularity of this type of plan. The portability of the individual policies also makes this arrangement attractive to highly-compensated executives who typically are selected to participate.

Early in the development of the group carve-out plan, employees were provided coverage with individual policies that still were a part of the group insurance plan ( Q 241). Currently, the purchase and ownership of individual life insurance policies often is structured in one of several ways, including a split dollar arrangement ( Q 4017), an IRC Section 162 bonus plan (see Q 272), or a death benefit only arrangement ( Q 101).

Under a group carve-out plan, the income tax consequences to both employer and carved-out employees are the same as if the alternative method of providing life insurance coverage existed independently of the group term plan. In a possible exception to this general rule, however, the IRS concluded in a technical advice memorandum released in 2000 that a split dollar arrangement entered into as part of a group carve-out plan should be taxed as group term life insurance. Thus, the economic benefit taxed to an employee was measured by Table I rates ( Q 246) rather than the insurer’s substitute rates that were used with the split dollar arrangement ( Q 4018).¹ Despite this, it seems almost universally accepted by practitioners that a group carve out plan structured as split dollar should be taxed as a split dollar plan and not as group term under the Table I rates.