With a traditional life insurance policy, the beneficiary is obvious. The individual who obtains the policy will name someone, often a spouse or child, who will receive a payout upon death. When it comes to corporate owned life insurance policies, however, it is more complex. Here is a look at how corporate owned life insurance works and who can ultimately benefit from this policy.
What Is Corporate Owned Life Insurance, And Who Benefits From It?
Corporate owned life insurance, or COLI for short, is a type of life insurance policy purchased by a business for its use. These policies are usually used to insure an employee or group of employees, a debtor, or a company owner.
It is essential to distinguish COLI from group life insurance policies businesses offer their employees to take advantage of group rates. With a COLI, the policy’s beneficiary is the corporation itself. In contrast, group life insurance policies through one’s employer can typically be assigned the beneficiary of the employee’s choice, such as a family member. In other words, the former benefits the company while the latter benefits the employee.
When corporate owned life insurance policies have been structured correctly, the cash value the policy accumulates will not be subject to federal income tax. If necessary, a business can borrow against the policy and deduct the interest paid on the policy loan. In addition, the premiums paid on these policies are considered business expenses and will be tax-deductible as long as the coverage is for the company’s executives or employees.
How Does Corporate owned Life Insurance Work?
An organization will purchase a cash-value life insurance policy for a particular employee and pay its premiums; they will also be the beneficiary of the policy and have the right to the policy’s cash value buildup and death proceeds.
An employee will not be interested in the policy other than being listed as the insured party. They will not pay any premiums on the policy, nor will their loved ones receive anything from it when they pass away.
Nevertheless, companies are required by the IRS to inform employees in writing that they plan to purchase COLI in their name and disclose the terms of the policy itself. They can only purchase these policies once they have obtained consent from the employee who will be named as the insured. However, most employees are willing to provide their consent because it is in their best interest for their employer to have solid financial strategies in place to protect the business.
In addition, companies are only permitted to buy these policies for their top 35% of employees based on salary and compensation. They must inform the IRS via the yearly filing of Form 8925 listing information about who is covered, or they could face significant penalties.
They must also demonstrate that they have what is known as an insurable interest in each employee for which they purchase a policy in terms of the potential for loss to the business should that employee die.
These rules were instituted in response to companies taking advantage of tax loopholes in the past related to the tax-free death benefits of corporate owned life insurance policies.
How Companies Can Benefit From Corporate Owned Life Insurance Policies
Corporate life insurance policies are profitable in many ways to meet a business’s goals. A COLI policy is often purchased to fund employee benefits and non-qualified deferred compensation plans. COLI policy’s offer those who participate in the plan reassurance that any cash flow issues experienced by the company will be unlikely to compromise their benefits. In this sense, employees benefit from such policies.
COLI policies can also be purchased as part of a strategy for buying out a business partner or owner when they pass away through a buy-sell agreement or to buy their shares of company stock.
A COLI may also be used to insure a key individual at the company to use the death benefits to replace that person if they pass away. Significant expenses can often be involved in finding and recruiting a suitable replacement for those with the highest company positions.
Although businesses can use many strategies that involve corporate owned life insurance policies, the ultimate beneficiary is always the corporation itself. Therefore, the company must provide accurate information when setting up COLI policies.
Discuss Corporate Owned Life Insurance Policy Strategies With the Benefits Specialists
There are many ways your company can use corporate owned life insurance policies to reduce financial risk. Still, it is crucial to understand the implications of the various options before choosing the best path forward. Contact the experienced benefits specialists at Vector Benefits to set up an appointment to discuss the best COLI strategy for meeting your business’s objectives and how it can benefit your business.