What it means
A company can depend heavily on a founder, specialist or manager, and a death may mean recruitment costs, interrupted sales or financing needs. Life insurance can provide cash at that point, though the proceeds do not replace the person's expertise.
The business typically pays premiums and owns the contract, so it should identify the insured employee and who receives benefits, since the employee's family is not necessarily the beneficiary simply because their life is insured. COLI is different from a group-life benefit intended for employees' chosen beneficiaries, because both insure lives but policy ownership, premiums and proceeds may be allocated differently, and the certificate and company agreement should be read.
A company may also use life-insurance cash values for long-term financial planning if the chosen policy provides them, though values, charges and tax consequences depend on policy type and a term policy may have no cash-value feature. COLI also creates governance questions, so the company should document why coverage is needed, who approved it, how the employee was informed and what happens if the employee leaves, while an insurer's underwriting rules can add other requirements.
US tax rules are especially important, as Internal Revenue Code section 101(j) restricts the exclusion of proceeds from gross income for certain employer-owned contracts unless statutory notice, consent and exception conditions are met. The required pre-issuance written notice includes the intent to insure the employee and a maximum face amount, written consent must recognise that coverage can continue after employment ends, and the employee must be informed that the business may receive proceeds.
The law provides several possible exceptions after notice and consent, including conditions tied to the employee's recent status or role and certain payments to family or an estate, so no single phrase such as key employee substitutes for checking the statutory facts. Investopedia says only the top 35% of employees can be insured under a COLI policy, but that misstates the rule, because a highly compensated category is one of several routes relevant to an exclusion exception, not a universal eligibility limit on purchasing a policy.
The article also says premiums are deductible as business expenses, whereas Internal Revenue Code section 264 generally denies a deduction for life-insurance premiums when the taxpayer is directly or indirectly the beneficiary. The precise tax analysis belongs to the governing contract and rules.
The IRS explains that section 6039I imposes reporting obligations for employer-owned contracts, so a business should verify its current filing duties and maintain notice-and-consent records rather than wait until a claim occurs. Tax-free proceeds are not guaranteed solely because the insured signed a consent form, since the contract date, insured status, beneficiary and applicable exception all matter.
An accountant or tax lawyer can review material amounts, and the useful decision is whether the expected protection and funding benefits justify premiums, controls and legal duties, never treating a glossy tax illustration as proof that a policy will pay a tax-free return.
In practice
Real-world examples.
Example
A small business insures a founder whose death would force costly replacement and working-capital spending. The board estimates six months of recruitment and lost sales at roughly $400,000 and sizes the policy against that figure, not against the founder's salary.
Example
A company records an employee's written pre-issuance notice and consent before taking out a US employer-owned policy. The notice states the intent to insure and the maximum face amount, and the signed consent is filed with the policy documents.
Example
A business checks whether policy premiums are deductible instead of assuming all insurance is an ordinary expense. Its tax adviser explains that section 264 generally disallows the deduction where the company is the beneficiary, so the premiums are budgeted as a non-deductible cost.
Formula
Calculation
Illustrative net financial proceeds = actual policy death benefit - outstanding policy loan - applicable unpaid charges or taxes. If the contractual benefit is $1 million and a $150,000 loan remains, a simple before-tax estimate is $850,000. This does not establish tax exemption: US notice, consent and exception rules need independent review.
Adding unpaid charges shows the effect of further deductions. If $10,000 of accrued charges are also outstanding, the estimate falls to $1,000,000 - $150,000 - $10,000 = $840,000. The company should model the figure it could actually receive, not the headline face amount.Case study
Seen in the real world.
Fictional example: A design firm depends on its lead engineer and considers a company-owned $1 million policy. Management compares premiums and other ways to manage succession risk. Before issuance, it provides the written employee notice and obtains informed written consent as required for the proposed US arrangement.
The finance team asks a tax adviser to examine section 101(j), reporting and section 264 premium deductibility. It models cash available after any policy loan rather than promising a $1 million tax-free windfall. The engineer's family is told clearly who the policy beneficiary will be.
Watch out
Common mistakes.
- Assuming employer-owned policy premiums are automatically deductible.
- Treating notice and consent alone as a guarantee that all death proceeds are tax-free.
- Mistaking a particular highly compensated employee exception for a universal rule that only the top 35% may be insured.
Questions
People also ask.
Does the employee's family receive the proceeds?
Not necessarily. The policy's beneficiary designation controls; the business may be the beneficiary.
Are premiums deductible in the US?
Not automatically. Section 264 generally disallows a deduction when the paying business benefits directly or indirectly.
Can a policy continue after employment?
It may, depending on terms. US notice and consent rules specifically address the possibility of continuation after termination.
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