Benefits and Beyond: What Happens to PTO, Health Insurance, Retirement Plans, and other Benefits?
When an employee passes away, their benefits don't just vanish into the HR ether. There's a surprising amount of paperwork, plan rules, and tax codes that come into play—and yes, you'll probably need to call your benefits administrator (and maybe your benefits lawyer). The general rule applies – if there is a designated beneficiary, then any benefits go directly to that designated beneficiary – end of story. If not, well then, those benefits typically belong to the estate and should not be distributed until you receive direction from the personal representative of the estate. Also, if you have a beneficiary designation for a plan that is NOT subject to the Employee Retirement Income Security Act (ERISA) (e.g., a bonus plan or an equity plan), please understand that there is always a possibility that underlying state law may conflict with the beneficiary designation and state law typically controls. If you have a potentially contentious situation, consider consulting with a benefits attorney before you process payments.
Accrued Vacation/PTO: Pay It Out or Let It Go?
In California and many other states, accrued vacation and PTO are considered wages—which means they must be paid out just like final wages. Sick leave, on the other hand, is usually not payable unless your policy or local laws says otherwise.
Pro tip: If your policy is silent, don't assume silence is golden. Check your handbook before you cut that check, and follow the process required for final wages after death in your state.
Health Insurance: COBRA to the Rescue
When an employee dies, if the employee was carrying their spouse and dependents on their employer-sponsored healthcare policy, their spouse and dependents may be eligible for COBRA continuation coverage for up to 36 months. Employers should:
- Notify the plan and/or COBRA administrators promptly,
- Avoid promising "we'll keep the cost the same"—unless you really mean it (and can actually do it—the administrative processes and IRS rules applicable to subsidized COBRA premiums can be very complex).
Life Insurance: The One Benefit Everyone Remembers
If your company offers group life insurance, now's the time to dust off those beneficiary forms. The insurer will handle the payout, but you'll need to:
- Notify the carrier,
- Provide a death certificate,
- Confirm the beneficiary on file (and hope it's not the ex-spouse from 2009)
- If an ex-spouse from 2009 is, in fact, named as the beneficiary (this happens all the time!), review the plan document to see if it includes any specific provisions regarding the validity of that election. If not, the ex-spouse is likely entitled to the benefit. Time to call your benefits attorney!
Bonus tip: Encourage employees to update their beneficiaries regularly. It's awkward when the payout goes to someone they unfriended years ago.
Retirement Plans: Let the Plan Do the Talking
401(k) and pension plans are governed by plan documents and federal law. Your job is to:
- Notify the third-party plan administrator,
- Provide necessary documentation,
- Stay out of the way unless and until you receive a request for further direction from the third-party plan administrator.
The third-party administrator will often engage directly with the family members and handle distributions to the designated beneficiary, and you'll avoid the risk of misdirecting funds. However, in more complex or potentially contentious cases, the third-party administrator may request direction from you before proceeding with a distribution. With these potentially contentious cases, don't rush to authorize the payout. If you rush, you may ultimately find out the plan paid the wrong person with no way to recover the funds, leaving you on the (financial) hook to process the same payment to the correct person. If your third-party administrator is asking you for direction, that's often a sign that it is a potentially contentious situation and a discussion with your benefits attorney might be warranted.
Extra Support: The Generous Employer's Dilemma
Sometimes, doing the right thing feels obvious—like covering funeral costs, offering a death benefit, or continuing health coverage for a grieving family at the active employee rate. But in the world of employment law and tax codes, good intentions can come with unintended consequences (and IRS forms).
"We Want to Help" — That's Great! But...
Employers often want to go above and beyond when an employee passes away. Common gestures include:
- Paying out unused sick leave (even if not required),
- Offering a lump-sum death benefit,
- Continuing salary for a period of time,
- Covering funeral or memorial expenses,
- Subsidizing COBRA coverage.
All of these are generous—and potentially taxable, reportable, or legally complex.
Tax Traps to Avoid
- Posthumous wages are still considered compensation and must be reported on a Form 1099-MISC (not a W-2) if paid after the year of death.
- Death benefits may be treated as taxable income to the recipient unless structured through a qualified plan or insurance.
- Gifts from the company (e.g., funeral contributions) may be taxable unless they meet narrow IRS exceptions.
- Subsidizing COBRA may inadvertently result in taxable income to the covered family members if not structured correctly.
Translation: If you're writing a check out of kindness, make sure it doesn't come with a surprise tax bill for the grieving spouse.
ERISA and Benefit Plan Pitfalls
If you offer a death benefit that looks like a retirement or welfare plan (e.g., continued salary or life insurance), you might accidentally trigger ERISA obligations. That means:
- Plan documents,
- Fiduciary duties,
- Annual filings,
- And possibly a call to your ERISA counsel.
How to Be Generous—Safely
- Be proactive and review your existing death benefit policies for clarity and legal compliance before an employee passes away.
- Coordinate with legal and tax advisors before offering anything outside your standard policies.
- Document the intent and structure of any payments.
- Communicate clearly with the family about what's being offered, advise them to consult with their own tax professionals to determine how it will be taxed, and when to expect it.
Pro Tip:
If you want to offer ongoing support, consider setting up a formal employee assistance fund or life insurance benefit in advance. It's cleaner, clearer, and far less likely to trigger a call from the Department of Labor.
Final Checklist: Don't Let Grief Lead to Legal Trouble
When an employee passes away, emotions run high—and so can legal risk if you miss a step. Best to develop a formal process/checklist based on your employee population to help HR and payroll teams stay compliant, compassionate, and clear-headed.1
Conclusion: A Final Act of Respect
Losing an employee is never just a policy issue—it's a human one. But in the midst of grief and logistics, employers have a unique opportunity: to handle the final details with care, clarity, and compassion. Whether it's issuing a final paycheck, navigating benefits, or offering extra support to a grieving family, every step you take sends a message about your values.
Yes, the rules are complex. Yes, the paperwork is real. But getting it right isn't just about compliance—it's about honoring someone's contributions in a way that's both lawful and meaningful.
So, take a breath, follow your processes, and don't be afraid to ask for help. Because when it comes to final pay and benefits, doing the right thing matters—both on paper and in people's hearts.
Footnote
1. This article does not deal with extremely rare circumstances which should be discussed with counsel, such as the application of a "slayer statute" (slayer statutes exist in most states and operate to bar a person responsible for the death of another from receiving any financial benefit.)The application of slayer statutes can be complex and varies by state, and a full discussion is beyond the scope of this article. Employers facing such circumstances should consult legal counsel to ensure compliance with applicable laws.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
