The Fundamentals of Corporate-Owned Life Insurance Taxation

The Fundamentals of Corporate-Owned Life Insurance Taxation

You are likely already familiar with individual life insurance policies, but did you know that there is also a corporate-owned option where you are the primary beneficiary? Find out more about this type of policy and whether it is right for your organization.

What is Corporate-Owned Life Insurance Taxation?

Corporate-owned life insurance, often referred to as COLI, is fully owned by the employer. He or she is responsible for paying the non-deductible premiums and is designated as the main beneficiary. Death benefits are paid out to the corporation or designated by the employer to be given directly to the employee’s family. The employer retains all rights and ownership of the policy, including the cash value.

Is COLI Taxable?

COLI policies are a tax-deferred asset for the employer. The death benefits from a COLI policy are usually free from federal taxation. However, there are limits. The benefit paid can not be greater than the total that the employer paid into the policy through premiums and any other amounts. Benefits in excess of this amount are treated as income and subject to all applicable taxes.

What Are the Advantages and Disadvantages?

There are both pros and cons to taking out a COLI policy. The top advantages include:

  • COLI policies can accumulate a tax-free cash value that you may be able to borrow against.
  • Your corporation is guaranteed to recover most if not all the value of a qualified plan.
  • You can limit any potential strain on your finances that may result from paying out benefits by matching the asset value to meet the liability.
  • Non-Qualified Deferred Compensation policies (NQDCs) are structured so that your corporation’s current cash flow does not affect any benefits.

Potential disadvantages of a corporate-owned life insurance policy are:

  • There are some instances where you may be subject to an alternative minimum tax.
  • You must carefully choose your provider. If they are experiencing financial hardship, you may be unable to access the cash value of the policy at a time that benefits are due to be paid.
  • There could be a discrepancy between the actual and estimated earnings, leaving an amount insufficient to pay benefits.

The advantages and savings of a group policy can be a significant incentive that offsets any drawbacks. You should discuss your corporation’s needs and unique circumstances with a knowledgeable provider who can offer advice and recommendations tailored to you.

Who is Eligible?

There are several restrictions in place to regulate corporate-owned life insurance policies to prevent employers from taking advantage of tax breaks. It is now required that all employees must be informed of the policy, and they need to sign an agreement to verify their approval. Any employee who doesn’t wish to be covered under COLI cannot be punished by their employer for their refusal.

Further, only the top 35 percent of the employees receiving the highest pay within the corporation can be covered under a COLI policy.

What Are DPSP Contributions?

Another popular benefit that employers favour is the Deferred Profit-Sharing Plan or DPSP. This is an alternative type of pension fund where the employer gives his employees a portion of the company’s profits. The funds are then invested into a tax-free account. The employee only has to pay tax on the funds when they are withdrawn from the account.

DPSPs are usually used in combination with more traditional retirement plans. Employers benefit because their contributions are tax-deductible. Both DPSPs and COLI policies are great supplemental benefits to more traditional plans.

Understanding your options for various policies and making the right decision for your employees and your company can be a complex process. Get the details and support you need to make the right choice. For more information about life insurance and group benefits, contact us at DBA today.

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