Life insurance through a professional insurance agency can provide you and your family with financial protection in the event of your sudden passing. However, some life policies are purchased by institutions and companies instead of individuals for liquidity. Complex rules surrounding corporate-owned life insurance are much more detailed than group or individual policies. Here’s all you need to know:
Purpose and nature of corporate-owned life insurance (COLI)
As per the name, COLI is life insurance that corporations purchase for their own use. It’s either the partial or total beneficiary for a group of employees, individual employees, debtors, or owners that are insured.
Corporate-owned life insurance differs from other life insurance policies structured to protect the employees and their financial dependents, not the company. COLI can help a business accomplish different objectives based on its structure.
One common objective is to provide funding for different nonqualified plans, like split-dollar life insurance policies, that give the company a chance to recoup the premium outlay by calling itself the main beneficiary of the premium it paid. The remainder goes to the employee or group of employees who are insured.
Another form of corporate-owned life insurance is key person life insurance—this pays a death benefit to the company upon the passing of a key employee. Meanwhile, buy-sell agreements help fund a buyout of the deceased owner or partner of a certain business. The death benefit is often used to buy the deceased person’s company shares. Many companies also use COLI to recover the costs of funding different employee benefits.
History of corporate-owned life insurance
COLI has been around for more than a century—its nickname originates in Russia, where 19th-century feudal serfs were sold and bought like property by rich folk. The ruling class could ‘buy’ serfs who had passed away but were counted in a previous census by their previous owners. This morbid attempt was made to get collateral for loans.
Companies in America used COLI after another 100 years to exploit a certain Internal Revenue Code loophole that allowed them to perform tax arbitrage. This allowed owners of life insurance policies to get large loans from their policy’s cash value before paying a certain amount of deductible interest back into their policy, which wouldn’t be counted as a source of income.
The IRS (Internal Revenue Service) eventually limited the loophole to around $50,000 per policy, but many firms continued to use COLI as a sort of tax shelter, where they would buy life insurance policies for their lower-tier employees without their consent or knowledge to take out loans.
Companies received large tax deductions that were often much greater than the cost of the premium. Alongside that, companies would collect the employee’s death benefit, leaving little for their estate or family. This activity finally stalled in the 1990s as the IRS took these practices to tax courts.
COLI and tax laws in the present
There are extremely complex tax rules when it comes to COLI. Life insurance is a great tax-advantaged vehicle—a death benefit from any life policy will always be free from tax. However, it isn’t always true for a policy that a corporation owns. To decrease the amount of tax evasion committed by the use of corporate-owned life insurance, it must now meet certain criteria to be advantageous for tax:
- A company can only purchase a COLI policy on the top one-third of their employees
- Employees who are insured according to a COLI policy need to receive a written notification beforehand
- The insured employee has to be aware of whether the company is a total or partial beneficiary of the insurance policy.
These notifications might not be necessary only under two instances. If an employee who worked for the company in the past year passes away, or if a highly-compensated employee or director passes away.
There has been much debate about whether other beneficiaries, such as the insured employee’s family, could also receive a tax-free benefit. The laws and rules of taxation for corporate-owned life insurance are rather complex, so it’s best to consult a financial advisor before making any decisions.
We provide high-quality health insurance services in CA
If you want to learn more about corporate-owned life insurance or invest in providing life insurance for your precious employees, top insurance agents at Covered California Certified Agent can help you out. We’ve got years of experience working with different companies from various industries so that you can be confident in the quality of our services. Whether you’re looking for employee insurance, group insurance, life insurance, or dental insurance, we’ve got you covered.
Our goal is to help you find the perfect plan that benefits you and your employees according to your budget and health requirements.
Reach out to us today by dialing 800-771-7653.