Corporate-owned life insurance (COLI)

Corporate-owned life insurance is a policy a company buys on the life of an employee, usually an executive or other key person, with the company as owner and beneficiary. Large employers commonly use COLI to informally fund nonqualified deferred compensation or retiree benefit costs; smaller firms use it as key person insurance or to fund a buyout. bank-owned life insurance is the banking-industry version.

The company pays premiums with after-tax dollars, the cash value grows tax-deferred, and the death benefit can be received income-tax-free if the rules are met. Hypothetical example: a company owns a $2 million policy on its chief engineer to cover the cost of recruiting and training a replacement. When the engineer dies, the proceeds arrive tax-free because the company followed the notice-and-consent rules.

Those rules matter. After controversy over policies on rank-and-file workers that paid employers without the workers' knowledge, Congress added Internal Revenue Code Section 101(j) in the Pension Protection Act of 2006. For employer-owned policies issued after August 17, 2006, the death benefit is taxable above the premiums paid unless the employee was notified and consented in writing before issue and an exception applies, such as the insured being a director or highly compensated employee. See corporate- and bank-owned life insurance and section 101(j) notice and consent.