Chapter 20: Applications in Employee Benefits Planning – Essentials of Personal Financial Planning



Willis and Katherine Adams just moved to the community because of new jobs: Willis was recruited to lead a new call center for one of the major appliance manufacturers; Katherine just completed nursing school and was hired by the regional hospital. Both employers are large (with over 100 employees) and well-established companies offering above-average salaries, but the real attraction was the outstanding employee benefit packages. Willis and Katherine were eager to take full advantage of the benefits available to them—and with good reason. Willis’s mother is 68 and has early onset dementia. Unable to afford any residential options for her, the Adamses have opted to have Willis’s mother live with them. She is listed as a dependent on their Form 1040 because she is without resources and does not qualify for Social Security benefits. While Katherine was in nursing school, she was the primary caregiver for Willis’s mother, but now that Katherine has a full-time job, the Adamses have hired an in-home care provider. Currently, they anticipate about $10,000 per year of adult day care expenses.

The Adamses purchased a beautiful house big enough for them and Willis’s mother. They have the house of their dreams, but between the house purchase and the costs of adult care, they are feeling a bit of a cash flow pinch. Exacerbating their cash flow problem is the fact that, with their new salaries, they find themselves in a much higher tax bracket than before. Having a dual income household and no children, they are in one of the higher marginal tax brackets: federal 25 percent and state 6 percent. Also, given their precarious financial situation, Willis and Katherine are terrified of the impact of a loss of income, should one of them become seriously injured or even die.

The Adamses have called you for an appointment. They would like advice on how to ease their cash flow worries and how to help defray the cost of care for Willis’s mother. They are also confused by the array of insurance types available to them through work and would like your advice. At present, they only have automobile and homeowners insurance. What items would you have them bring to the meeting, and what ideas or recommendations might you consider before the meeting?


After completing this chapter, you should be able to do the following:

  Identify the types, characteristics, and uses of group insurance.

  Apply professional responsibilities and standards to employee benefits planning.

  Identify income tax planning opportunities and applications within employee benefits planning.


The term employee benefits refers to any benefits provided by a company other than basic compensation. In previous chapters, we discussed some of the most common employee benefits: health insurance, life insurance, and disability insurance. Although insurance is certainly one of the biggest and most helpful benefits available to employees, it is far from the only one. Benefits can include everything from gym memberships to education reimbursement, from transportation incentives to free meals. In a competitive job market, a robust employee benefit plan can provide a real advantage to employers, making the additional costs of the benefits themselves a good investment in attracting, and retaining, top-level talent. For employees, these benefits, most of which are received income-tax free, can sometimes be a bit confusing. Employee benefits planning can help individuals navigate complex insurance situations and maybe even get a free gym membership or lunch.

Personal financial planners tend not to offer employee benefits planning to their clients. One possible reason for the lack of planning in this area has to do with compensation. For planners who are compensated through the sale of products rather than for advice, there are no corresponding products to sell to their clients with regard to employee benefits. This is a tremendous detriment to clients because, for most of them, employee benefits represent much more than a simple perk. They can be a terrific boon to individuals, as long as they are properly managed. This chapter will address the area of employee benefits and its integration into the personal financial planning process.

Group Insurance Benefits

As we noted in the introduction to this chapter, insurance is the biggest and most common employee benefit. Employers can offer myriad types of insurance, although most employer-sponsored insurance falls into the health, life, and disability categories. Regardless of the specific types of insurance, the one great advantage is the power of pooling from a large group of people to offer either simplified underwriting, lower overall rates, or both. In this section, we will examine the various types of group insurance provided by employers. For many employees, employer-provided insurance through group plans is their only insurance.


Group disability insurance is a single contract that covers an insured group with a common nexus, such as an employer, profession, or school affiliation. The cost of group coverage is often less expensive than individual coverage, but the benefits are more restrictive. Premiums may be paid by the sponsoring entity or by the individual participants in the group.

Because underwriting is simplified, the benefits provided by group disability insurance are more restrictive. Typically, benefits are only provided for either total disability or modified own-occupation disability. The latter provides benefits for two years at the employee’s current occupation, and thereafter benefits are only available if the disability is total. Modified underwriting is offered to the group because the risk of disability is borne by the entire group rather than by an individual.

A group disability plan may provide long-term coverage, short-term disability coverage, or both forms of coverage. Short-term disability coverage provides benefits with a maximum benefit period of not more than 26 weeks. Short-term disability coverage may replace 50 percent to 100 percent of pre-disability earnings.

Long-term disability benefits begin once the short-term disability coverage benefits end and usually last until age 65. Long-term disability coverage benefits replace up to 60 percent of pre-disability earnings.

Like traditional disability income contracts, group disability plans require that the employee satisfy an elimination period. For short-term disability coverage, that period is typically after an employee’s sick days have been used up. Most employers provide a limited number of sick days annually to employees—typically 7 to 14 days. Long-term disability coverage has an elimination period of 90 to 180 days, or, if integrated with the short-term group disability plan, it begins when the short-term benefits end.

Disability benefits received by a disabled employee are potentially both income taxable and income-tax free. Benefits are income-tax free for that portion of the premium paid for by the employee. The portion of the benefits which represent the employer’s contribution are reportable as income. Group disability benefits may be offset by disability benefits payable under Social Security, workers’ compensation, or individually owned disability insurance of the employee.


Like group disability insurance, group life insurance offers somewhat restrictive coverage at a lower price point than individual life insurance. There are many types of group life insurance but, as shown in exhibit 20-1, they all have some characteristics in common.


Guaranteed issue up to specified limits based on the group plan’s design.

Modified underwriting (typically five health-related questions) for the purchase of additional insurance.

Convertibility to permanent life insurance products offered by the insurance company underwriting the group plan.

The main types of group life insurance are as follows:

Accidental death and dismemberment (AD&D). This insurance provides an accidental death benefit equal to the employee’s basic term life insurance amount and also provides a percentage of the basic accidental death benefit amount for qualifying injuries.

Annual renewable term (ART). As discussed in chapter eight, this is term insurance with a level death benefit and a premium that increases each year.

Group universal life insurance. This is a universal life insurance contract in which the employer pays for the cost of insurance, and any premium payments made by the employee are used to accumulate cash values in the contract.

Some group plans offer employees, at retirement or separation from service, the ability to convert their group term insurance to a nongroup term insurance contract or a permanent cash value policy. An analysis would need to be performed by the personal financial planner as to whether or not the client benefits by exercising this option.

Under IRC Section 79, an employee must include in gross income an amount equal to the cost of group-term life insurance on the employee’s life provided by the employer which exceeds $50,000 in death benefit. Amounts less than $50,000 of death benefit on the life of the employee, and $2,000 of death benefit on the life of the employee’s spouse or dependent, are not reported and are not included in the employee’s income.


An employee may remove the death benefit from a group life insurance policy from their estate by assigning their group life insurance policy to an irrevocable trust (IDGT/ILIT). The IRS has determined that the ability for an employee to cancel a group term policy by terminating current employment is not an incident of ownership. As with the transfer of any existing life insurance, the policy proceeds from the group term insurance will be included in the insured’s gross estate if the insured does not survive the transfer by at least three years.

When the insured’s employer pays the premiums on the group term policy, it is treated as an indirect gift by the insured to the trust. In order to ensure that the federal gift tax annual exclusion is available to offset these indirect gifts, the beneficiaries of the irrevocable trust should be given a Crummey withdrawal power.


As you have seen in previous chapters, medical insurance comes in many different forms. Group medical insurance is no different. The following sections discuss typical group medical insurance options, as well as some legislative considerations that affect group medical coverage.

Traditional Indemnity

Traditional indemnity medical insurance covers hospital, surgical, and physician’s expenses. This insurance typically is in the form of a hospital indemnity or surgical indemnity-type policy. The benefits provided by these contracts are very limited in nature (for example, $50 per day for a maximum of 15 days; or if you have a gall bladder removed, for instance, a benefit of $5,000 is paid). Exhibit 20-2 shows the two basic types of indemnity plans.


Hospital indemnity. Pays a fixed amount ($50/day, for example) and only provides benefits when the insured is hospitalized.

Surgical indemnity. Pays according to a schedule that lists the surgical procedure and the amount that will be paid in the event of a claim ($1,000 for open heart surgery, for example).

Managed Care Plans

Unlike a traditional indemnity plan, managed care plans come in several varieties. The focus of a managed care plan is cost containment for both the insurance company and the employee. The personal financial planner must be familiar with the various plan designs in order to make reasoned recommendations as to which of the managed care plans to recommend.

Health maintenance organization. A health maintenance organization (HMO) provides a range of comprehensive health care services to a group of subscribers in return for a fixed premium known as capitation. Capitation is a fixed amount of money per patient, per unit of time, paid in advance to the physician for the delivery of health care services. An HMO uses a gatekeeper—the primary care physician responsible for determining what care is received and when the patient should be referred to specialists. Subscribers are required to obtain their care from providers affiliated with the HMO. The patient or subscriber is not covered when using a provider outside the HMO (unless for an emergency).

Preferred provider organization. A preferred provider organization (PPO) represents a group of healthcare providers who contract with insurance companies, third-party administrators, or other entities to provide medical care services at a reduced fee. Exhibit 20-3 shows the two major respects in which a PPO differs from an HMO.


Providers of health care in a PPO are generally paid on a fee-for-service basis, as needed, unlike an HMO, which has a flat subscription fee.

Participants in a PPO are not required to use the practitioners or facilities of the PPO. Participants are able to go outside of the network; however, benefits are reduced relative to benefits paid for network-provided care.

Point of service. A point-of-service (POS) plan combines features of both an HMO and a PPO. POS plans have a primary care physician; however, unlike an HMO, the primary care physician does not dictate when the patient should be referred to specialists and does not act as a gatekeeper. And, like a PPO, participants may go outside of the network for services.

Qualified high-deductible plans. A qualified high-deductible health plan (HDHP) can be an HMO, a PPO, or a POS. Participation in this type of plan is required in order to contribute to a health savings account (HSA). These plans have a higher annual deductible and copay amounts than traditional medical insurance.

COBRA Benefits

Under the Consolidated Omnibus Budget Reconciliation Act (COBRA), employers providing group or self-funded health coverage are required to offer terminated employees the right to purchase continued health care coverage identical to their existing coverage. Smaller employers, with fewer than 20 employees for at least half of the prior year, are exempt from this requirement. See table 20-1 for qualifying events under COBRA.

Terminated employees and other dependents Voluntary or involuntary termination; change from full time to part time 18 months
Spouses and other dependents Employee’s death, divorce, legal separation, or eligibility for Medicare 36 months
Children of employees Loss of dependent status (marriage, reaching dependency age limit specified by plan) 36 months

Health Insurance Portability and Accountability Act (HIPAA)

One of the main purposes of the enactment of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) was to ensure the security of health insurance coverage for those who had insurance at a previous job. Prior to HIPAA, an employee may have been unable to move from one employer to another because of a preexisting conditions clause in the new employer’s health plan. A preexisting condition is defined as one in which medical advice, diagnosis, care, or treatment was recommended or received within the plan’s specified time period prior to enrollment in the plan, or if the plan has an elimination period, prior to the first day of the elimination period. This was referred to as job lock. HIPAA states that there would be no preexisting condition exclusion if an employee was covered by the prior employer’s health plan for 12 months or more, and less than 63 days had elapsed since losing coverage under the prior employer’s plan. The prior employer was required to provide a certificate certifying the length of prior coverage.

As a result of the Affordable Care Act (ACA), portability is no longer an issue and preexisting health conditions are no longer a barrier to changing employers.


A Section 125 cafeteria plan is an employer-sponsored reimbursement plan that allows employees to make elective deferrals into a benefit account. The benefit account can be used for a variety of expenses such as insurance premiums and other medical care expenses and dependent care expenses not covered by insurance. Employee contributions and deferrals are made on a pretax basis and are not subject to Social Security, federal, or state income taxes.

In order for the employee contributions to be considered tax-free deferrals, the election to defer compensation must be made before it is earned, typically before the end of the prior calendar year. The employee maintains a record of expenses and makes a claim on the plan for reimbursement. There are three basic types of Section 125 cafeteria plans.

Premium-Only Plan

A premium-only plan (POP) allows employees to pay their portion of insurance premiums with pretax dollars. Typical group insurance offered within a premium-only plan includes accidental death and dismemberment, dental, health, life (up to $50,000), and vision. Note that premiums for long-term care insurance are not permitted.

Flexible Spending Account

A flexible spending account (FSA) is used by an employee to pay for medical expenses not reimbursed by insurance, such as deductibles, co-payments, and coinsurance for the employee’s health plan. Expenses not covered by the employee’s health plan, such as dental, vision, and over-the counter drugs, may also be reimbursed by an FSA. An employee may elect to defer up to $2,550 (2016) into his or her FSA. All amounts must be used by the end of the grace period, which is two months and 15 days immediately following the end of the plan year. Alternatively, the plan may elect to permit the use of up to $500 of unused amounts in the health FSA in the following plan year.

Dependent Care Assistance Plan

The dependent care assistance plan (DCAP) is used by an employee to pay for day care, nursery school, preschool, before- and after-school care, adult day care facilities, and adult in-home day care. The maximum DCAP deferral amount is $5,000 for 2016. Exhibit 20-4 shows who can qualify for care under a DCAP.


A child under the age of 13 when the care was provided and who can be claimed as a dependent on the employee’s income tax return

A dependent who is mentally or physically challenged and can be claimed as a dependent on the employee’s income tax return

A spouse who is mentally or physically challenged


As of the writing of this book, only one insurance company is offering group long-term care insurance. The claims experience for the underwriters of group long-term care insurance was adverse and, as a result, many companies have left the marketplace. For the present, the vast majority of long-term care insurance provided by employers is actually multi-life individual insurance plans. These are individual long-term care insurance contracts offered by an employer that are usually issued with simplified underwriting and other concessions. Employer contributions toward premium payments continue to be tax deductible to the employer and not included as wages for the employee (see chapter 9).


Group dental insurance is a form of health insurance expense coverage, and as such it is deductible by the employer and not included in the employee’s compensation. In the marketplace, there are two primary types of plans—indemnity and managed care. Plan benefits vary from simple, basic benefits (no orthodontic care) to a wide range of benefits.


Group vision insurance provides employees with an annual eye exam and discounts on ancillary services provided by optometrists, not ophthalmologists. The benefits received over the course of the year typically equal the premium payments made for the group vision coverage. Services may be provided in and out of network, much like a PPO. The real benefit of vision insurance is that it levels out the cash necessary to purchase eyeglasses or contacts on an annual basis.

Other Employee Benefits

Although insurance is the primary type of employer-sponsored benefit, it is not, as we noted earlier, the only one. In this section, we explore the other types of benefits that might be offered by employers—and there are many.


A fringe benefit is compensation for the performance of services, and the services do not necessarily have to be provided to an employee. Independent contractors, partners, or directors who perform services for a business may receive fringe benefits. Fringe benefits are provided by an employer to foster employee satisfaction and retention; depending on the type of benefit, they may or may not be income taxable. Table 20-2 shows some types of fringe benefits.

Accident and health benefits Accident and health benefits paid for self-
employed individuals, partners, and more than
2 percent owners of an S corporation are taxable
income. One hundred percent is deductible as an
adjustment to income on the front of Form 1040.
Group-term life insurance up to $50,000 of coverage Premiums for group-term life insurance in excess
of $50,000 of coverage
Discounts on services, limited to 20 percent of the price charged to nonemployee customers  
Educational assistance limited to $5,250  
Occasional overtime meal money, cab fare, theater or sporting event tickets  
Transportation benefits:

Transit passes ($255/mo. cap)

Qualified parking ($255/mo. cap)

Qualified bicycle commuting ($20/mo. cap)



An employee is permitted to use a business vehicle to commute to and from work. The value of this benefit is included on the employee’s Form W-2. There are many ways to value this benefit. The simplest method is the IRS option of a $1.50 one-way commute fee.


An adoption assistance program supports adoptions by employees by providing reimbursement of adoption expenses. The IRS establishes the maximum amount of employer-provided adoption assistance that may be excluded from wages. The 2016 maximum exclusion amount is $13,460. Participants must take the adoption-assistance exclusion in the year the employer makes the payments.

An adoption assistance program is a separate written plan that meets all of the following requirements:

The program does not pay more than 5 percent of its benefits to shareholders or owners (or their spouses or dependents) during the calendar year.

Notice of the program is provided to eligible employees.

Employees must provide reasonable substantiation that payments or reimbursements are for qualifying adoption.

Specific rules apply to more than 5 percent owners and highly compensated employee.


A de minimis benefit is any property or service provided to an employee that has so little value that accounting for it would be unreasonable or administratively impracticable. An employer can exclude the value of de minimis benefits provided to an employee from the employee’s wages. Cash and cash equivalent fringe benefits are never excludable, except for overtime meal money or transportation fare.

Examples of de minimis benefits include the following:

Personal use of an employer-provided cell phone to be used primarily for business purposes

Occasional personal use of a company copying machine (no more than 15 percent should go to personal use)

Holiday gifts, other than cash, with a low fair-market value


There are two types of employee achievement awards—qualified and nonqualified. A qualified employee achievement award is one given as part of an established written plan or program that doesn’t favor highly compensated employees as to eligibility or benefits. The award can be any tangible personal property given to an employee as an award for either length of service or safety achievement. It is excluded from income as long as the award does not exceed $1,600 (2016). The qualified exclusion doesn’t apply to awards of cash, cash equivalents, gift certificates, or other intangible property such as vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, and other securities.

If the award is not part of a qualified employee achievement award program, then it is a nonqualified employee achievement award, and the amount of the award cannot exceed $400.


Like the adoption assistance program, the educational assistance program is a separate written plan that provides educational assistance to employees. The program qualifies for tax-favored status only if all of the following tests are met:

The program does not pay more than 5 percent of its benefits to shareholders or owners (or their spouses or dependents) during the calendar year.

The program does not allow employees the choice to receive cash or other benefits instead of the educational assistance.

Notice of the program is provided to eligible employees.

Specific rules apply to more-than-5-percent owners and highly compensated employees.

The employer may exclude up to $5,250 of educational assistance provided to an employee under an educational assistance program from the employee’s wages each year. If an employee receives educational assistance in excess of $5,250, the excess must be included as wages, unless the benefits are working condition benefits. Working condition benefits are excluded from wages if the benefit provided by the employer, could have been deducted by the employee as an employee business expense had the employee paid for the benefit directly. Other examples of working condition benefits include an employee’s use of a company car for business or an employer-provided cell phone provided primarily for noncompensatory business purposes.


Prepaid legal service plans are employer-funded and the premiums are deductible by the employer. Benefits are included in compensation to employees.


An employee may exclude from wages the value of certain retirement planning services provided by an employer maintaining a qualified retirement plan. The services may include general advice regarding the employee’s overall plan for retirement, of which the employer’s qualified plan is only a part. The employer cannot exclude from the wages of a highly compensated employee retirement planning services that aren’t available on the same terms to each member of a group of employees normally provided education and information about the employer’s qualified retirement plan.


The value of employer-provided outplacement services must be reported as income when the employee accepts these services in exchange for reduced severance pay. Otherwise, the fringe benefit is not taxable.


An employer can exclude from compensation any occasional meals provided to an employee if it has so little value that accounting for it would be unreasonable or administratively impracticable. The exclusion applies, for example, to the following items:

Coffee, doughnuts, or soft drinks

Occasional meals or meal money provided to enable an employee to work overtime (However, the exclusion doesn’t apply to meal money figured on the basis of hours worked.)

Occasional parties or picnics for employees and their guests

This exclusion also applies to employer-provided meals in an employer-operated eating facility for employees, if the annual revenue from the facility equals or exceeds the direct costs of the facility.

When food or beverages furnished to employees qualify as a de minimis benefit, the employer is able to deduct their full cost; the 50 percent limitation for meals and entertainment does not apply.


On-premise athletic facilities provided to employees are nontaxable, if substantially all use of the on-premise athletic facility during the calendar year is by employees, their spouses, and their dependent children.


The reimbursement of moving expenses is nontaxable only when the employee is able to deduct the expense, if he or she had paid or incurred them without reimbursement.

Chapter Review

Employee benefits are any benefits provided by a company other than basic compensation. These most commonly include various types of insurance, but they can also include everything from achievement awards to moving expenses. Taking advantage of even the most basic employee benefits can be a huge assistance to most people; taking advantage of the full range of available benefits, though, requires careful planning and a good deal of thought. Unfortunately, personal financial planners often choose not to provide employee benefits planning, usually because this type of planning does not really allow for the sale of additional products to their clients.


1. What items would you have the Adamses bring to the meeting?

Personal financial planners would do well to ask for their client’s employee benefit books. These documents provide a plethora of information for the planner.

2. Before even meeting with them, what ideas or recommendations might you consider?

Use existing employee benefit programs to address the economic risk of a potential loss of income as the result of premature death, disability, accident, or illness.

It is very likely that one or both of their employers has a Section 125 cafeteria plan in place. These plans, combined with their group insurance benefits, provide an opportunity to address the economic risks mentioned previously.

The potential tax savings from using a cafeteria plan is approximately 38.5 percent of the amount of the Adamses’ deferral. This tax savings has the potential to pay a portion of their insurance coverage. Therefore, you may want to suggest the following:

a. The Adamses purchase the maximum amount of group disability insurance.

b. The Adamses purchase the maximum amount of group term life insurance.

c. The Adamses consider, if available, participating in a dependent care assistance plan for Willis’s mother’s care. By maximizing the DCAP plan ($5,000), the Adamses more than recover the cost of the insurance purchased through their employer (tax savings: $5,000 × 38.5%).

As a result of your meeting, their cash flow has improved, and their insurance is being provided by the federal government through a reduction in income and payroll taxes.



1. Jack works for Peterson Millworks, is married, and has two children. Peterson Millworks offers a PPO to its 50 employees. If Jack and his wife Alice were to divorce, which of the following is or are correct?

I. Alice and Jack’s children will be eligible for 36 months of COBRA coverage.

II. Alice will be eligible for 18 months of COBRA coverage.

III. Alice will be eligible for 36 months of COBRA coverage.

IV. Jack will be eligible for 18 months of COBRA coverage.

A. I, III.

B. II.



2. Which fringe benefits are income taxable?

A. Employee achievement awards.

B. On-premise athletic facilities.

C. Prepaid legal services.

D. Occasional personal use of a company copying machine.

3. Who qualifies for a dependent care assistance plan?

I. A dependent child who was under the age of 18 when the care was provided.

II. A dependent who is mentally or physically challenged.

III. A relative who is mentally or physically challenged.

IV. A spouse who is mentally or physically challenged.

A. I, II.


C. II, IV.

D. I, II.

4. Which pays a fixed amount and only provides benefits when the insured is hospitalized?

A. Hospital indemnity.

B. Managed care plan.

C. Point of service.

D. Surgical indemnity.

5. An employee may exclude from wages the value of certain ______ planning services provided by an employer maintaining a qualified retirement plan.

A. De minimis.

B. Fringe benefit.

C. Prepaid investment services.

D. Retirement.

6. Which is eligible to be considered an employee achievement award by an employer?

A. Cash.

B. Tangible personal property.

C. Tickets to a sporting event.

D. Vacation.

7. Which is required in order to participate in an HSA?

A. Health maintenance organization.

B. Point of service.

C. Preferred provider organization.

D. Qualified high-deductible plans.

8. Which is considered an indirect gift by an employee to a trust?

A. Contributions to an adoption assistance program.

B. Irrevocable assignment of group term life insurance.

C. The revocation of a Crummey withdrawal right.

D. Use of prepaid legal services.

9. Dr. Dante DeMarco, dermatologist, wants to provide fringe benefits to his staff. Which fringe benefits can be provided income-tax free to his employees?

I. 50 percent off on microdermabrasion.

II. $100,000 group life insurance.

III. Occasional theater tickets.

IV. Qualified parking.

A. I, II.

B. I, IV.


D. II, IV.

10. Benefits from which employer-provided plans will be received by the employee income-tax free?

A. $7,000 in educational assistance.

B. Group disability plan paid for by the employer.

C. Prepaid legal services plan paid for by the employer.

D. Retirement planning services.


1. Download the current version of IRS Publication 15-B, The Employer’s Tax Guide to Fringe Benefits. What benefits cannot be included in a cafeteria plan?

2. What resources are available to employers to explain de minimis fringe benefits?

3. What kind of resources for employees are available from the U.S. Department of Labor?

4. What online tools and calculators are available to employees to figure the tax benefits available to them through their Section 125 cafeteria plans?

5. What are your rights under HIPAA?