Corporate Owned Life Insurance

What is corporate-owned life insurance?

Corporate-owned life insurance (COLI) is typically taken out on a group of critical employees and pays a benefit when any one of those employees dies. COLI policies are a way for a corporation to minimize its tax burden, increase after-tax net income, finance employee benefits, and cover the expense of replacing an insured employee upon that employee’s death.

Companies pay the premiums and own the cash value of the policies. Companies are also the beneficiary of the insurance. The insured employees do not receive any of the insurance benefits directly, nor do they pay any of the premiums. The coverage does not replace any other insurance owned by the employee or provided by the company.

What are the requirements for corporations to purchase COLI policies?

To take advantage of a tax-free death benefit from COLI, corporations must meet certain requirements from the Internal Revenue Service.

  1. Companies can only purchase COLI policies on the top 33 percent of employees ranked by compensation. They usually represent a group of selected management or highly compensated employees.
  2. It must notify the employee or employees in writing of the terms of the policy before purchasing. Death proceeds paid on an “employer-owned life insurance contract” will remain tax-free only if proper notice is given to the covered employee and the employee gives written consent to be insured before coverage is issued.

What are the tax regulations for COLI program?

The proceeds paid to the corporation upon the death of the employee are generally tax-exempt if the corporation is both the owner and beneficiary of the life insurance policy.

The proceeds from corporate-owned life insurance policies maybe taxable to the corporation upon receipt. Life insurance premiums paid to a corporation upon the death of an employee will be excludable from income only to the extent of any premiums or other amounts paid for the policy. Proceeds in excess of such costs will be taxable to the corporation.

In order for the entire amount of life insurance proceeds to be tax-exempt to the beneficiary corporation, the employee must:

  • Be notified in writing that the applicable policyholder intends to insure the employee’s life;
  • Must provide written consent to being insured and that the coverage may continue after the insured terminates employment;
  • Must be informed in writing that employer will be a beneficiary of any proceeds payable upon the death of the employee.

Corporations owning one or more employer-owned life insurance contracts must file a Form 8925 for each year, showing:

  • The number of employees at the end of the year and the number of those employees insured under employer-owned life insurance contracts;
  • The total amount of insurance in force under such contracts at the end of the year;
  • The name, address, TIN, and type of business of the applicable policyholder;
  • That the applicable policyholder has a valid consent for each insured employee or the number of insured employees for which no consent has been obtained.

Who are ideal customers that need a COLI program?

Companies that are interested in COLI programs often have three characteristics:

  • high profitability
  • reasonable liquidity
  • unfunded employee benefit liabilities

High profitability ensures a company to afford the insurance expenses for its core employees. A reasonable liquidity can help minimize the impact of the deaths of executives and employees on the finances and smooth running of the company. This insurance attracts companies that have unfunded employee benefit liabilities since the benefits from the death payouts of workers and the tax-free buildup within the policies can be utilized to offset the liabilities and finance the retirement benefits costs.

What are the benefits of COLI program?

  • COLI death benefits can be used to help the company recover plan costs over the long term. This insurance policy helps hedge against the financial costs that came about as a result of the loss of life of key employees and the risk of recruiting and training the replacements for the deceased key employees.
  • This insurance provides a way for the company to earn additional income which usually exceeds what the company pays in premiums. The income generated from the insurance can be used to carry out other business operations.
  • COLI can earn a competitive after-tax yield compared to other investments

What are the risks of COLI program?

If the insurance company experiences severe financial difficulties, the company may not be able to access the policy’s cash value to pay the plan benefits.

Corporations should evaluate an insurance company’s financial stability and earnings history before purchasing COLI.

There may be a disparity between the estimated earnings and the actual earnings, which may leave the company with insufficient cash to pay premiums when due.



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