It’s called corporate-owned or company-owned life insurance, and it’s commonly referred to as COLI. It may also be referred to as Key-Person Life Insurance. But what is it?
COLI, or Key-Person life insurance, is a life insurance policy taken out by a company on the lives of employees whom the company considers to be of critical importance to operations. In this type of plan, the company pays the premium on the insurance – but it’s also the primary beneficiary.
In the current fiscal environment, protecting jobs and employee benefits has never been more important, and COLI serves both of these functions.
There are a few reasons why a company would take a life insurance policy out on key employees. For one, the tax-free proceeds that are received after the death of a key person can be used to cover any costs that would arise when hiring that individual’s replacement. The insurance policy can also be used to cover employee benefit liabilities.
However, the most notable benefit to a company that institutes a COLI policy comes from the benefit to after-tax net income. This benefit arises when the cash value of the policy becomes larger than the premiums paid. According to an industry survey, 68% of the Fortune 1000 companies use COLI programs.
In the recent past, congress and the IRS cracked down on COLI’s by limiting their application to the upper one-third of employees of a company according to their compensation. The “insured” must now be provided written notification of the existence of the policy, the amount of the payout and the name or names of any beneficiaries listed on the policies. If the corporations follow the rules, a tax-advantaged status of the death benefits is still in force.
COLI is a life insurance policy used by employers to keep businesses running and protect jobs after the death of owners or key employees. It also is used to finance employee benefits, including broad-based health, disability, survivor and supplemental retirement benefits.
Through COLI, employers are taking the responsible step of setting aside assets to protect jobs and to make sure they are able to deliver on their employee benefit promises. Employers do not receive a tax deduction for purchasing COLI and employees pay nothing but receive substantial benefits in connection with the product.
Congress has consistently reaffirmed the benefits of COLI. Most recently, it enacted the Pension Protection Act of 2006 on a broad bi-partisan basis after three years of study, enhancing requirements and safeguards by codifying COLI best practices with new section 101(j) of the Internal Revenue Code
Indeed, well before the PPA and section 101(j), it was common practice for employers to take out COLI only on highly compensated employees after notice and informed consent. Section 101(j) makes clear that COLI can only be taken out on officers, directors and highly compensated employees with notice and their informed consent. To ensure compliance, the IRS requires annual reporting by employers on COLI usage. Non-compliance results in the taxation of policy proceeds. The PPA locks in the responsible use of COLI by making non-compliance economically untenable. COLI should be seen for what it is: a way for responsible employers to protect jobs and benefits.