A Guide to Corporate-Owned Life Insurance

 Corporate-Owned Life Insurance (COLI) is a type of life insurance taken out by a business on an employee's life. Companies can do this even without the employee's knowledge or consent. When an employee dies, the policy's payout goes to the company rather than the individual's loved ones.

Coverage under a COLI policy may continue for up to a year after an employee leaves their position. Because some corporations have exploited COLI tax loopholes, the Internal Revenue Service (IRS) now requires them to meet specific standards to earn a tax-free death benefit. The company can only buy COLI coverage for 35 percent of the highest-paid employees.

There are several potential benefits of COLI for businesses. Businesses use after-tax dollars generated from operations to pay for life insurance policies. This allows for lower taxes, which can result in more money being available for investment or other purposes like salary increases without sacrificing the company's bottom line with high rates and expensive coverage options that may sometimes be unnecessary.

When a business owns a policy on an individual shareholder, the policy usually protects the individual shareholder from the creditors of the individual shareholder. With the right setup, it is possible to keep beneficiaries' death benefits safe from the company's debt collectors.

A company can pay for the premiums of several shareholders or key people, even if the costs of the premiums are different for each person because of their age or health. Therefore, each shareholder will receive an equal part of the future cost and benefit of the premiums the company pays. This is preferable to having each shareholder pay for their insurance coverage since it makes premium payments more evenly distributed.

Furthermore, the business can easily manage various policies for its shareholders and employees through centralized administration. This includes making premium payments, validating the status, or claiming benefits from an insurance company.

For tax purposes, a company with a permanent insurance policy can deduct the cash surrender value as an asset until the money is redeemed or withdrawn. This allows corporations more flexibility when it comes time to invest and diversify their assets without having a significant amount invested in one type alone.

If the insured passes away, the company may pay out the life insurance payout to the insured's loved ones as a tax-free capital dividend. Subtracting the policy's adjusted cost basis (ACB) from the death benefit yields a tax-free payout; holding a policy until death makes it possible to pay the death benefit tax-free.

COLI can be constructed in various ways to achieve many business goals. The informal funding of specific kinds of nonqualified deferred compensation (NQDC) schemes is a frequent goal of COLI. The business may get a death benefit from the key employee's life insurance, and buy-sell agreements may be utilized to buy out the deceased owner's or partner's stake in the company if the key employee has one.

Using COLI as a source of unofficial funding for an NQDC strategy is not without its share of dangers, just like any other economic activity. Using a COLI insurance to informally finance an NQDC plan can deliver significant tax savings and cash flow benefits to the corporation while being exempt from most Employee Retirement Income Security Act of 1974 (ERISA) regulations, provided the plan is structured correctly.