We want to provide our employees with a death benefit that is similar to life insurance such that when an employee dies, his/her beneficiary/estate will receive a nominal amount. We are not purchasing a policy to insure the death benefit but rather are paying any benefit ourselves. Is the benefit taxable, and if yes, can we structure it so it isn't taxable to the beneficiary (we don't want to purchase a group life insurance policy however.) Thanks in advance for any responses.

it will be taxable; no way around that

ipod:
What about paying these benefits through a self-funded VEBA?
Don Levit

Don Levit: What Section of the IRC says that death benefit money paid by a VEBA is tax-free?

ipod:
Section 101(a).
Also see Private Letter Ruling 199921036.
Don Levit

Don Levit: Very interesting. I thought you were emphasizing the "VEBA" aspect of the equation. I never realized IRS had interpreted "life insurance contract" so broadly. Seems like a long road to travel simply to save taxes on a "nominal amount," but if the cost ends up being less than the cost of buying insurance I guess it can be a good idea.

If cash flow is not a concern, you could gross up the benefit payment to the beneficiary. This would be much simpler than setting up a VEBA.

Don't forget about accruing for the benefit in a DBO plan - not required when you purchase life insurance unless you promise benefits post-retirement.