Corporate-owned life insurance is a type of life insurance policy that will make a payout to the company that contracts the policy in the event that an insured employee dies.
Also known as company-owned life insurance or COLI, these policies are typically taken out on one or a series of critical employees. The company is responsible for paying the insurance premiums on the policy, and they also receive the death benefit when the employee passes away.
This is often used as a way to minimize a company’s tax burdens, and there may be other benefits as well. For example, it may be used as a financial strategy for covering the expenses associated with replacing insured employees upon their death and financing employee benefits. In many cases, these policies will continue to cover an employee for up to a year after they have left a company.
What Are The Requirements For Obtaining A Corporate-Owned Life Insurance Policy?
In the past, obtaining a corporate-owned life insurance policy was relatively easy. Many companies used them to insure against the death of key employees, such as upper executives. However, some companies that were looking to exploit tax loopholes started to purchase these policies for lower-ranking employees without their knowledge and paid premiums on them even long after the employee had left the company.
In response to companies using these policies as a means of taking advantage of certain tax loopholes, the Internal Revenue Service has made some changes to the requirements for receiving the tax-free death benefits of this type of policy. A company is now only permitted to purchase these policies for the top 35 percent of their employees in terms of compensation. They are also required to notify the employee who will be insured by this policy in writing of the policy’s terms and obtain written consent from the employee prior to purchasing the policy.
There must also be an insurable interest on the company’s part for every employee that they insure. This means they need to demonstrate the potential for loss should the employee die to justify their purchase of the policy. Businesses must also report all of their company-owned life insurance policies to the IRS each year using form 8925.
Taxation And Corporate-Owned Life Insurance
The premiums that companies pay on corporate-owned life insurance policies are considered expenses and are tax deductible as long as the coverage is for the company’s higher-level employees.
When Should Companies Consider Corporate-Owned Life Insurance?
There are several situations where a company may want to pursue corporate-owned life insurance as a business strategy. Here is a look at some of the most common situations where it may be a suitable approach.
Loan Protection
When a small business obtains a loan, the lender may require the owner to personally guarantee the loan and obtain life insurance for key individuals with the company for the loan’s duration. However, it is considered good practice to obtain these policies any time a company obtains a loan, even if the lender does not specifically require it. Otherwise, a personal guarantee could be a liability of the owner’s estate, which would make the estate responsible for paying any outstanding debts the business is unable to cover.
Buy-Sell Agreements
Another situation where corporate-owned life insurance can be valuable is in cases where a business’s partners would be interested in buying out the shares owned by another shareholder in the event of their death rather than allowing the deceased shareholder’s families to become involved in the business.
The proceeds from this type of policy can buy out the shares owned by a deceased shareholder’s estate or their beneficiaries to ensure that the business can continue while providing the beneficiaries of the deceased party with cash. In these cases, the specific process will typically be outlined in a shareholders’ agreement.
Protecting Key Individuals
Some businesses may have certain key individuals who would be very difficult to replace if they passed away. Even if the individual is replaceable, it could take a significant amount of time to secure a replacement who is capable of operating at their same level. This can compromise a business’s profitability and efficiency. In these cases, a corporate-owned life insurance policy can be used to give a company the cash flow it needs to hire and train replacements or shore up working capital.
Contact The Benefits Specialists At Vector Benefits
A corporate-owned life insurance policy can help your business to reduce its financial risk, but it is essential to follow all of the relevant regulations and employ an informed strategy to get the most out of this approach. Reach out to the experienced benefits specialists at Vector Benefits today to learn more about our services and how we can help you with your COLI.
