Bank-Owned Life Insurance: How It Works, Benefits and Tax Rules

Banks are in the business of managing money, but one of their lesser-known financial strategies involves something most people associate with personal planning: life insurance. Bank-owned life insurance, or BOLI, is a tool that thousands of banks across the country use to fund employee benefits, boost their balance sheets and take advantage of favorable tax treatment. It’s a significant asset class in the banking industry, yet most people outside of finance aren’t aware of it.

A financial advisor can help you assess how bank-owned life insurance fits into your business’s financial plan.

What Is a Bank-Owned Life Insurance Policy?

Bank-owned life insurance is a type of life insurance policy that a bank purchases on the lives of its key employees or officers. The bank is both the owner and the beneficiary of these policies, meaning it receives the death benefit when an insured employee passes away. While the concept might sound unusual at first, BOLI is one of the most widely used financial tools in the banking industry, and has been for decades.

Banks purchase BOLI primarily as a way to offset the rising costs of employee benefits, particularly for executives and senior-level staff. The cash value inside these permanent life insurance policies grows on a tax-deferred basis, giving banks a stable, long-term asset that helps fund obligations like retirement plans, deferred compensation and health insurance.

Unlike a standard life insurance policy that an individual might buy to protect their family, BOLI is a corporate-owned product designed to serve the financial interests of the institution. The insured employees generally don’t receive any direct benefit from the policy, and their families are not the beneficiaries. Instead, the bank uses the policy’s cash value as an asset on the balance sheet asset and, as mentioned above, collects the death benefit to recover costs associated with providing employee benefits.

Types of Bank-Owned Life Insurance Policies

A couple review a life insurance policy.

Banks have several options when it comes to choosing a BOLI policy, and each type comes with its own risk profile, return potential and level of flexibility. The right choice depends on the bank’s financial goals, risk tolerance and how actively it wants to manage the investment component of the policy. Here are the three main types of BOLI policies used in the banking industry:

General account BOLI: The bank’s cash value is held in the insurance carrier’s general account, meaning the insurer guarantees a minimum rate of return and assumes the investment risk. It’s a popular choice for banks that prioritize stability and predictable growth over higher potential returns.
Separate account BOLI: With this structure, the policy’s cash value is invested in a separate account that functions similarly to a mutual fund. Separate account BOLI appeals to banks that are comfortable with some volatility in exchange for greater upside potential.
Hybrid account BOLI: A hybrid policy blends features of both general and separate account BOLI, offering a middle ground between guaranteed returns and market-based growth. Part of the cash value is held in the insurer’s general account for stability, while the remainder is invested in a separate account for additional return potential.

Choosing the right type of BOLI policy is a decision that can have lasting implications for a bank’s balance sheet and overall financial health. Because each structure carries different levels of risk, return potential and regulatory considerations, it’s important for the bank’s leadership to work with a qualified financial advisor or insurance consultant before making a commitment.

Tax Considerations for Bank-Owned Life Insurance Policies

The tax advantages of BOLI are a major reason banks find these policies so attractive, but the rules governing them are nuanced. From tax-deferred growth to income tax-free death benefits, BOLI offers several financial perks that few other bank assets can match. However, there are also important limitations and potential pitfalls that can erode those benefits if the policies aren’t managed carefully.

One of the primary tax benefits of BOLI is that the cash value inside the policy grows on a tax-deferred basis. This means the bank doesn’t owe income taxes on the gains as they accumulate, allowing the investment to compound more efficiently over time. Compared to taxable investment alternatives, this deferral can result in significantly higher net returns over the life of the policy.

When an insured employee passes away, the death benefit paid to the bank is generally received free of federal income tax. This allows the bank to recover its investment in the policy and then some, with the full proceeds available to offset employee benefit costs or strengthen the balance sheet.

While holding a BOLI policy offers clear tax advantages, surrendering one can trigger a significant tax bill. If a bank decides to cash out a policy before the insured employee dies, any gains above the bank’s cost basis are subject to ordinary income tax. This makes BOLI a long-term commitment, and banks that surrender policies prematurely may find that the tax consequences wipe out much of the financial benefit they originally expected.

Risks and Considerations of a Bank-Owned Life Insurance Policy

BOLI can be a powerful financial tool for banks, but it’s not without its risks and trade-offs. Like any long-term institutional investment, it’s important to carefully evaluate BOLI policies before purchase. Ongoing oversight after the policies are in place may also be necessary.

One of the biggest drawbacks of BOLI is that it ties up capital for a long period of time. Unlike more liquid assets on a bank’s balance sheet, BOLI is designed to be held until the insured employee dies. Surrendering a policy early not only triggers taxable gains, but may also come with surrender charges from the insurance carrier, further reducing the bank’s net return.

When a bank purchases BOLI, it’s placing a significant amount of trust, and money, in the financial strength of the insurance company issuing the policy. If the carrier experiences financial difficulties or becomes insolvent, the bank’s cash value and future death benefit could be at risk. This is particularly relevant for general account BOLI, where the policy’s value is directly tied to the insurer’s general fund.

Bottom Line

A couple decide on a life insurance policy.

Bank-owned life insurance is a widely used and financially efficient tool that helps banks offset the costs of employee benefits while adding a stable, tax-advantaged asset to their balance sheets. With options ranging from conservative general account policies to more growth-oriented separate and hybrid structures, banks can tailor their BOLI programs to match their specific risk tolerance and financial goals. However, the benefits come with real trade-offs, including limited liquidity, carrier credit risk, regulatory obligations and potential ethical concerns.

Life Insurance Tips

Your selection of an insurance policy can have a major impact on your finances, as well as your beneficiaries’ finances. If you’re unsure of which policy to go with, a financial advisor may be able to help. Finding the right financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Want a better way to understand how much life insurance you should buy? Our free life insurance calculator can give you a solid estimate of what’s right for you and your loved ones.