Corporate-Owned Life Insurance: Types, Benefits and Tax Rules

Most people think of life insurance as something you buy to protect your family. However, in the corporate world, it serves an entirely different purpose. Corporate-owned life insurance (COLI) is a financial strategy that allows companies to purchase policies on the lives of their employees. The business, not the employee’s family, is the beneficiary. This practice has been used for decades to fund executive benefits, offset rising employee costs and financially protect against the loss of key personnel.

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

What Is Corporate-Owned Life Insurance?

It may seem unconventional for a company to hold life insurance on its workers. However, corporate-owned life insurance (COLI) is a well-established financial strategy popular with businesses of all sizes across a wide range of industries.

COLI is a life insurance policy that a company purchases on the lives of its employees. This typically affects key executives and senior leaders. The corporation owns the policy, pays the premiums and is the beneficiary. This means it receives the death benefit when the insured employee passes away.

Companies don’t purchase COLI simply to profit from an employee’s death; the policies serve a legitimate and strategic financial purpose. Businesses use COLI primarily to help fund long-term liabilities. This includes executive compensation packages, deferred retirement benefits and post-retirement healthcare obligations.

The cash value that builds inside these permanent life insurance policies acts as a company asset. It grows tax-deferred over time.

Overall, COLI operates very differently from the life insurance policy someone may buy to protect their family. With a personal policy, the insured individual or their loved ones are the beneficiaries. With COLI, the company receives the financial benefit, not the employee or their family.

Employees must provide written consent before a policy can be taken out on their life. ¹ This is a federal requirement to ensure transparency and protect individual rights.

Common Uses of Corporate-Owned Life Insurance

One of the primary uses of COLI is to informally fund non-qualified deferred compensation plans for executives and senior leaders.

These plans allow companies to promise future payments to key employees as a retention and recruitment tool. The cash value inside a COLI policy provides a dedicated asset to back those promises.

The cost of providing employee benefits like health insurance and pension plans continues to rise for companies of all sizes. COLI helps offset these expenses by generating tax-advantaged returns through the policy’s cash value and eventually, a tax-free death benefit.

When a company’s success is closely tied to a small number of individuals, the unexpected loss of one of those people can be financially devastating. COLI provides a financial cushion that helps the business absorb the impact. It can cover costs like executive search fees, lost revenue and client transition expenses.

Closely held businesses and partnerships frequently use COLI to fund buy-sell agreements between owners. When an owner dies, the COLI policy’s death benefit kicks in. It gives the surviving owners or the company the capital to purchase the deceased owner’s share.

This ensures a smooth ownership transition without forcing the business to take on debt or liquidate assets under pressure.

Types of COLI Policies

Not all corporate-owned life insurance policies are the same. The type of policy that a company chooses will shape its risk profile, return potential and overall fit within its financial strategy.

There are a few main types of COLI policies that businesses typically consider.

• Whole life insurance. Whole life is the most straightforward and conservative option. It offers guaranteed cash value growth, a fixed death benefit and level premiums that never change.
• Universal life insurance. Universal life provides more flexibility, allowing companies to adjust premium payments and death benefit amounts within certain limits. The cash value earns interest based on a fluctuating crediting rate set by the insurance carrier.
• Variable universal life insurance. With variable universal life, the policy’s cash value is invested in a selection of sub-accounts similar to mutual funds. This gives companies the potential for higher returns. However, it also exposes them to market risk, since the cash value can decrease if the underlying investments perform poorly.
• Indexed universal life insurance. Indexed universal life ties the policy’s cash value growth to the performance of a market index, such as the S&P 500. It typically includes a floor that protects against losses. This structure offers a middle ground between the guaranteed returns of whole life and the market exposure of variable universal life.
• Group COLI. Rather than purchasing individual policies on specific employees, some companies opt for a group COLI arrangement. This covers multiple employees under a single contract.

Potential Risks of Corporate-Owned Life Insurance

COLI is for the long haul, so accessing capital isn’t always easy or cost-effective.

Surrendering a policy early often triggers surrender charges from the insurance carrier. Any gains above the company’s cost basis become taxable as ordinary income. ² This combination can significantly reduce the net value the company recovers. It makes COLI a poor choice for businesses that may need flexible access to capital in the short- or medium-term.

The financial strength of the insurance company backing the policy is also a risk. If the carrier runs into financial trouble or becomes insolvent, the company’s cash value and future death benefit may be compromised. This risk is especially high with general account COLI, where the policy’s value relates directly to the insurer’s overall financial health.

COLI programs are subject to a complex web of federal regulations, and failing to comply can have serious consequences. Under Internal Revenue Code Section 101(j), companies must obtain written employee consent and meet specific notice requirements before issuing a policy to preserve the tax-free status of the death benefit. ³

Bottom Line

Corporate-owned life insurance is a strategic financial tool helping businesses of all sizes fund executive benefits, protect against the loss of key employees, support buy-sell agreements and manage long-term liabilities in a tax-efficient way. With several policy types available, from conservative whole life to market-linked variable and indexed options, companies can tailor their COLI programs to match their specific financial goals and risk tolerance.

Tips for Buying Life Insurance

• Consider talking to a financial advisor about life insurance. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area. You can then 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, begin now.
• Alternatives to the above-mentioned types of life insurance are less well-known but are sometimes worth examining. They include return-of-premium, endowment and no-exam policies, any one of which may be suitable for you.

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