When it Pays for an Employer to be a Life Insurance Beneficiary

That’s why for some employers corporate-owned life insurance (COLI) makes a lot of sense — life insurance purchased by a company on the life of an employee. When the employee dies, the company receives the death benefits. The company remains the beneficiary even after the insured employee leaves the firm — if the company continues to pay the premiums. COLI also may be written on a group of employees.

COLI protects a business from the unexpected death of executives and other employees who are essential to the business’ operation and whose absence could result in the loss of revenue and profits. It’s also a way for a company to recoup the time and investment it has made in its vital employees. Or it may be used to redeem shares of company stock held by the deceased, such as with a closely held business. Any money a company receives as the beneficiary is tax-free, as long as the insured employee qualifies as a company director or meets the Internal Revenue Service’s definition of a highly-compensated employee. Another financial benefit is that an employer can withdraw some or all of the built-up cash value or borrow against it to purchase employee benefit plans. Plans can be non-qualified executive health plans or deferred compensation plans. An employer also can take out loans through the policy for non-benefit related items. Unfortunately, premiums paid for the policy are not tax deductible.

If you decide to purchase COLI, you must choose either whole life or universal life insurance. With whole life, you are paid a death benefit and the policy accumulates a cash value, which you can use to withdraw funds or borrow against. Universal life is permanent life insurance with an investment savings element and low premiums, similar to term life insurance. The premium you pay for coverage includes the death benefit and administrative expenses, plus the savings account, which consists of funds invested in stocks and bonds. You also must decide what kind of corporate-owned life insurance you need. If you buy key person insurance on someone such as a partner or president, the company would be paid a benefit if that person dies and may also, depending on the policy and the situation, get paid disability benefits. Another option is split-dollar life insurance, which splits the death benefits between the company and an employee’s beneficiaries. With another variation, the employee’s beneficiaries receive the death benefit and the company receives the cash value or the amount it paid in premiums — whichever is greater. The company can cover the cost of the entire premium or the employer and employee can share the costs.

It probably won’t come as a surprise that COLI is controversial. Many people don’t appreciate the idea of a business benefiting from the death of an employee. Also, use of this kind of life insurance was abused in the 1980s and 1990s. Many companies took out policies on thousands of low-level employees without telling them. They justified the practice by claiming that they were using the proceeds to finance the increasing costs of health care and pension obligations. The practice made headlines in the 1990s when it was reported that Winn-Dixie secretly purchased life insurance, which it referred to internally as “dead peasants insurance,” on about 36,000 employees without their permission.

Congress sought to end abuse in 2006 when it passed the Pension Protection Act. The rules regarding corporate-owned life insurance include requiring:

Employers to provide written notice to employees of their desire to make the company the beneficiary of such a policy and how much the company will receive if they die.Written consent from employees before the policy is issued.That employers file IRS tax form 8925 at the end of each year. The form reports the number of employees covered by the insurance; the total amount of insurance in force; and whether they have a valid, written consent from each covered employee.

By not following the above provisions, a company with a COLI on an employee or employees will not be able to collect the death benefit if the employees pass away. Please contact us to learn more about COLI and whether it could be useful in your firm.