Corporate-Owned Life Insurance: Pros and Cons
I started Insurance Blog by Chris™ because I have a passion for insurance. Here at the blog, our job is to educate and inform people about the best insurance for them.
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Written by
Chris Huntley
Founder of Huntley Wealth & Insurance Services
Rachael Brennan has been working in the insurance industry since 2006 when she began working as a licensed insurance representative for 21st Century Insurance, during which time she earned her Property and Casualty license in all 50 states.
After several years she expanded her insurance expertise, earning her license in Health and AD&D insurance as well. She has worked for small health insu…
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Reviewed by
Rachael Brennan
Licensed Insurance Agent
UPDATED: Mar 28, 2022
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Here’s the Scoop
COLI policies can help you insure your business against the death of a key employee or partner
COLI policies pay the death benefit to the business rather than the employee or partner
The policies can be confused with group term coverage, but the beneficiary is the business instead of the employee
When most people think about business life insurance, they think about group term coverage. But, there is another type of life insurance policy called COLI, which is short for corporate-owned life insurance. And while the life insurance industry has many creative ways to use the coverage, COLI policies are gaining ground in the business insurance arena.
Group term life insurance typically covers the employee, and the employee gets to determine who is the beneficiary of the coverage. In COLI, the business owns the policy and would also receive the death benefit if the employee passes while the COLI policy is in force.
The business, not the employee, pays the COLI premiums. You typically use this type of policy to insure the lives of high-ranking executives or other employees whose death could have a significant financial impact on the business. If they die while the policy is in force, the business receives the death benefit.
Here, we will help you understand what a COLI is and then look at the pros and cons of corporate-owned life insurance—the coverage that has gained popularity with business owners in recent years.
What is corporate-owned life insurance (COLI) exactly?
COLI life insurance policies are a great way to protect your business. If a covered owner or key employee dies, COLI policies provide a lump sum payment to the business. This payment can help keep your business running, protect your employees’ jobs, or allow the business to buy out the deceased partner’s family.
COLI can provide critical funds at the death of an important employee or business partner. It is important to note that the business can take out COLI policies on more than one of its employees or owners. The coverage will allow you to insure the top 33% of your workforce.
COLI may be a less-expensive option for companies looking to take out one or more life policies on key people within the organization. And as long as the business follows the correct steps when placing the policy, the death benefit generally will be 100% tax-free. However, please note that premium payments are not tax-free.
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What are the pros of corporate-owned life insurance?
When used correctly, corporate-owned life insurance can significantly benefit a business. Some of the advantages of COLI include:
Protection for key employees: If a key employee dies, the business can use the proceeds from the policy to help offset the loss.
Estate planning: The tax-free death benefit from a COLI policy can help the business’ estate planning efforts by providing liquidity. Those funds can also help with unforeseen tax burdens, business expansion, or employee acquisition. The estate plan will dictate the use of the death benefit funds in the event of a covered death.
You can customize COLI policies to fit your business’ needs. COLI policies are not one size fits all. The number of people insured and the benefit amount can vary by policy.
The business can pool its risk by buying COLI insurance policies on the top 33% of its staff. The cap is the max number of employees the IRS says you can include on corporate-owned life insurance. Additionally, the IRS requires you to fill out form 8925 on each covered employee every year.
The business can also borrow against the policy’s cash value, which can provide liquidity in a time of need.
What are the rules of COLI?
COLI is an excellent option for a business looking to reduce the impacts of losing an important employee or partner, but this policy has a few caveats.
Businesses can only take out COLI policies on the top 33% of their employees.
When you add an employee to a COLI, you must notify them in writing before the insurance company issues the policy on them.
COLI’s death benefit will likely remain tax-free if the covered employee provided written consent before the policy was issued.
Another technicality potentially affecting the tax-free status of the beneficiary is that the owner of the policy (your business) and beneficiary must be the same.
The business must also inform covered employees that the policy proceeds go to the business rather than the employee.
Employees are the Lifeblood of a Business
When a business considers purchasing corporate-owned life insurance (COLI), the first question is why. The answer is simple: Employees are the lifeblood of a business. They are the ones who make things happen, and they are the most critical asset a business has.
If something happens to a key employee or partner, the business suffers a significant loss. COLI policies help the business recover and move forward with the least financial disruption possible when the worst thing happens. Aside from the very real challenges of losing a close partner or key employee, COLI policies help the business get back to focusing on what it needs and how to move forward.
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The Tax Advantages of Corporate-Owned Life Insurance
When it comes to corporate-owned life insurance tax treatment, COLI offers a couple of benefits you may be interested in. For example, the death benefits paid out are generally not subject to income tax.
Also, the COLI may build up cash value over time, depending on its structure. If the policy has cash value, the business may borrow money tax-free against the policy’s cash value. There is usually an annual interest fee on the cash value loan. You would typically pay the fee annually or, in some cases, charge it back to the remaining cash value of the policy.
What are the cons of corporate-owned life insurance?
Corporate-owned life insurance policies are often more expensive than individual policies.
If the business is the policy’s beneficiary, it can create a conflict of interest with the employee.
COLI policies can be expensive to set up and maintain.
If the policy is not structured correctly, the business could pay more in estate taxes than if the policy was not in place.
If the business goes bankrupt, the policy will often lapse, and any cash value built up will be absorbed by the bankruptcy.
Corporate-Owned Life Insurance
COLI is a life insurance policy owned by the business rather than the employee. Policies in amounts of $1 million or more are typical. In this type of policy, the employee’s death results in a death benefit payment to the business. The business can use the proceeds for anything.
Businesses also have a few other options to provide life insurance coverage for their employees. Many offer a group term insurance policy to all employees. Alternatively, the business can purchase coverage for individual employees through an individual life insurance policy.
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The Potential for Litigation
Usually, the life insurance beneficiary is typically the spouse or child of the policyholder. But when a corporation owns the life insurance policy on an employee, the business is the beneficiary.
If something happens to the employee, the business collects the death benefit. If the business can also make decisions about the employee’s care, this can create a conflict of interest.
For example, suppose an employee is injured, and the business owns their life insurance policy. In that case, the business may be more likely to make decisions about the employee’s care that benefit the business rather than the employee. Conflicts like this are typically resolved in the courts. Having the employee acknowledge and sign that they understand the coverage will provide leverage to jog memories and avoid court conflicts if there are any disagreements.
Before Deciding on Corporate-Owned Life Insurance, Carefully Weigh the Pros and Cons
No matter the direction you choose, make sure you understand the coverage and how it will work for you. Corporate-owned life insurance can be an excellent way for employers to reduce their losses when a covered individual passes away. It is also a great way to ensure the stability of your business should the worst thing happen to one of your best employees.
