What Is a Corporate-Owned Life Insurance (COLI) Policy?

Corporate-owned life insurance (COLI), also known as business-owned life insurance, is a strategic financial policy in which a company is both the owner and beneficiary. There are two main types of COLI insurance: key person life insurance and split-dollar life insurance.

Key person life insurance protects the company against financial losses that could result from the death of a key employee. Split-dollar life insurance is where the cost and benefits are shared between the employer and employee. Companies invest in COLI to safeguard critical human assets, manage financial risks and benefit from tax efficiencies.

Corporate-owned life insurance is a strategic asset for companies looking to mitigate financial risks associated with losing key personnel. There are two primary types of corporate life insurance, each serving distinct strategic functions within corporate financial planning:

• Key Person Life Insurance: This type of insurance provides financial stability if a key employee, such as a CEO or other pivotal staff member, unexpectedly passes away. The death benefit helps cover the costs associated with potential business disruptions, including recruiting and training a successor. This company-owned life insurance can be vital for maintaining business continuity by mitigating the financial impact of losing key talent.

• Split-Dollar Life Insurance: In a split-dollar arrangement, the cost and benefits of the life insurance policy are shared between the employer and the employee. This type of COLI is beneficial for both parties. It assists employees in obtaining life insurance at a reduced cost and allows employers to recover the premiums paid if the insured event occurs. This mutual benefit reinforces employer-employee relations and enhances financial security.

Corporate-owned life insurance policies are typically established with the company as the policy owner and beneficiary, which allows them to manage the policy and claim the death benefit should an insured employee die. This setup ensures the company can leverage these policies to support its financial and strategic objectives, such as funding employee benefits plans, executive compensation agreements or business succession plans.

Corporate-owned life insurance taxation presents significant financial advantages that are integral to corporate financial planning.

• Deferred Taxes on Cash Value Accumulation: The cash value of COLI policies grows tax-deferred. This means the company does not pay taxes on the interest, dividends or capital gains while they accumulate within the policy. This allows the cash value to increase faster than it would in a taxable account, making COLI a valuable asset for long-term financial strategy.

• Tax-Free Death Benefits: Under most circumstances, the death benefits paid from corporate-owned life insurance to the beneficiary company are received tax-free. This exemption provides a significant financial influx to the company, free from federal income tax, thus preserving the full value of the insurance payout.

These tax treatments make COLI an attractive option for businesses, as they enhance the financial benefits of the policies beyond mere risk protection.

Recent legislative changes, particularly those encapsulated in IRS Code Section 101(j), emphasize the importance of compliance with these requirements to maintain the tax-exempt status of death benefits. Failure to adhere can result in the proceeds being taxable. Businesses must keep detailed records and ensure all procedures are followed meticulously to avoid any tax liabilities​.

Companies invest in COLI insurance for various reasons. Generally, they do so to enhance their financial security and operational stability.

• Risk Management and Key Personnel Protection: COLI is often used as key person insurance, ensuring the company can manage financial risks associated with the untimely loss of key personnel. The death benefit provided acts as a financial safety net, allowing the company to cover recruitment and training costs or to offset the loss of critical skills and leadership without destabilizing operations.

• Financial Benefits and Asset Management: In most cases, COLI policies are permanent life insurance. This means they have a cash value that grows on a tax-deferred basis, providing a source of liquidity that can be accessed through policy loans or withdrawals. This liquidity can be essential for funding employee benefits, corporate expansion or other strategic investments without the immediate tax implications of other funding sources.

• Tax Advantages: The death benefits from COLI are generally received tax-free, offering a significant advantage when planning for long-term financial efficiency and corporate fiscal health.

Although corporate-owned life insurance offers tax and financial benefits, there are also associated risks that companies need to manage carefully.

• Liquidity: The cash value of a permanent COLI insurance policy can take time to grow. Withdrawing or borrowing against the policy may reduce the death benefit, potentially undermining the company's long-term financial planning.

• Potential need for large payouts: If the company insures multiple key employees and several deaths occur within a short period, it could face financial strain in paying premiums or adjusting its finances to accommodate multiple claims.

• Regulatory compliance: Failing to meet IRS requirements, such as notice and consent rules, could result in the loss of tax-free death benefits, further impacting the company's financial standing. Maintaining detailed records and ensuring compliance is essential for companies that own COLI life insurance policies

Below are answers to common questions about corporate-owned life insurance (COLI), helping companies understand how it fits into their financial strategies.