Generally, the term “corporate-owned life insurance” (COLI) is used to describe a life insurance policy paid for by a corporation, with the corporation being the owner and beneficiary. Although a COLI policy offers financial protection, there are strict and complex rules.
The Purpose of a COLI
Corporate-owned life insurance policies are legal but not widely used. Depending on the situation, the corporation that purchases a COLI policy is the partial or total beneficiary, with one employee, a group of employees, a debtor, or company owner being listed as the insured.
A COLI policy is commonly used as life insurance for a key individual so that in the event of death, the policy pays the death benefit to the company rather than family members. Often, the death benefit is used to purchase some, if not all of the company stocks owned by the deceased person. A COLI policy can also be used to recover the cost of funding different types of employee benefits.
Mechanics of a COLI Policy
Initially, the goal of COLI policies was to give companies protection against the death of high-ranking executives whose deaths would cause great revenue loss as well as significant expense in finding replacements. Over time, coverage included all employees, regardless of status, even those who had no knowledge of the COLI policy, as well as individuals no longer employed by the company.
However, with their increasing controversy from an ethical standpoint and in the eyes of the Internal Revenue Service (IRS) and Congress, tax loopholes for COLI policies were quickly closed. In the 1980s, several large corporations took out COLI policies on literally hundreds of thousands of employees, regardless of expertise or skillset. Once an employee died, the life insurance benefits were untaxed, which was lucrative for the corporation. Companies could also borrow money against the COLI policy, deducting interest paid as being a legitimate business expense.
During the mid-1990s, the IRS began denying the tax deductions and limiting the cash value of each policy to just $50,000. Then Congress passed COLI Best Practices, a provision of the Pension Protection Act of 2006, making the practice more difficult. Today, there are strict tax rules for corporate-owned life insurance policies that vary by state.
Of all tax vehicles, life insurance remains the most advantageous. While the death benefit from any individual or group policy is tax-free, this is not always the case of COLI policies. To limit corporate tax evasion using corporate-owned life insurance policies, several criteria must be met for them to be tax advantaged.
- Policies can only be purchased on the highest-compensated one-third of employees.
- An employee listed as an insured must receive written notification prior to the policy’s purchase. The notification must also include the amount of coverage and the company’s intent for insuring the person.
- The employee must receive written notification if the company is a partial or sole beneficiary.
With the terms being so complex, if you are interested in purchasing or selling a COLI policy or if you are an employee on which the company has taken out a policy, it is imperative that you speak with a reputable corporate attorney. Only then can you get the answers and guidance needed.