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

Most people think of life insurance as something you buy to protect your family, but in the corporate world, it serves an entirely different purpose. Corporate-owned life insurance, or COLI, is a financial strategy that allows companies to purchase policies on the lives of their employees, with the business, not the employee’s family, as the beneficiary. It’s a practice that’s been used for decades to fund executive benefits, offset rising employee costs and protect against the financial fallout of losing 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?

Corporate-owned life insurance, often referred to as COLI, is a life insurance policy that a company purchases on the lives of its employees, typically key executives or senior leaders. The corporation owns the policy, pays the premiums and is named as the beneficiary, meaning it receives the death benefit when the insured employee passes away. While it may seem unconventional for a company to hold life insurance on its workers, COLI is a well-established financial strategy used by businesses of all sizes across a wide range of industries.

Companies don’t purchase COLI simply to profit from an employee’s death, the policies serve a specific and strategic financial purpose. Businesses use COLI primarily to help fund long-term liabilities such as 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 that grows tax-deferred over time.

It’s important to understand that COLI operates very differently from the life insurance policy someone might 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, a requirement put in place by federal law 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, including health insurance, pension plans and retiree medical coverage, 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 providing 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, covering 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 death benefit from the COLI policy gives the surviving owners or the company the capital needed 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 built the same, and the type a company chooses will shape the policy’s risk profile, return potential and overall fit within its financial strategy. Here are the main types of COLI policies businesses typically consider:

• Whole life insurance: Whole life is the most straightforward and conservative option, offering guaranteed cash value growth, a fixed death benefit and level premiums that never change.
• Universal life insurance: Universal life provides more flexibility than whole life, allowing companies to adjust premium payments and death benefit amounts within certain limits. The cash value earns interest based on a crediting rate set by the insurance carrier, which can fluctuate over time.
• Variable universal life insurance: With variable universal life, the policy’s cash value is invested in a selection of sub-accounts that function similarly to mutual funds. This gives companies the potential for higher returns but 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, while typically including 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 that covers multiple employees under a single contract.

Potential Risks of Corporate-Owned Life Insurance

COLI is designed to be held for the long haul, and accessing the capital locked inside these policies isn’t always easy or cost-effective. Surrendering a policy early often triggers surrender charges from the insurance carrier, and any gains above the company’s cost basis become taxable as ordinary income. This combination can significantly reduce the net value the company recovers, making COLI a poor choice for businesses that may need flexible access to their 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 could be compromised. This risk is especially pronounced with general account COLI, where the policy’s value is tied 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. ¹

Bottom Line

Corporate-owned life insurance is a strategic financial tool that helps 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, 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.
• 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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