Life Insurance Interest: Commercial Policies And Earning Interest

Life insurance is a legally binding contract between an insurance company and a policy owner, where the insurer guarantees to pay a sum of money to the policy's beneficiaries when the insured person dies. Life insurance policies can be purchased by corporations for their own use, and this is referred to as corporate-owned life insurance (COLI). COLI can be used to pay off corporate debt, shore up operating capital, and buy out shareholders' estates.

There are two basic categories of life insurance: term and permanent. Term life insurance provides coverage for a specific period and is the least expensive type of insurance, while permanent insurance is designed to be maintained long-term until death and includes universal life, whole life, and term-to-100 policies. Universal life and whole life policies offer an investment component where additional funds are paid into the policy, forming an investment component that grows tax-free.

The rules pertaining to corporate ownership of life insurance are more complex than those for individual or group policies, and the tax rules are fairly intricate as well. For instance, in the case of COLI, the corporation is either the total or partial beneficiary on the policy, and an employee or group of employees, owner, or debtor is listed as the insured.

Commercial loans from life insurance companies

Life insurance companies offer commercial real estate loans with terms ranging from 5 to 30 years. These loans are typically non-recourse, limited-recourse, or full recourse and have fixed interest rates for the duration of the loan. The loans are available for various property types, including multifamily, office, warehouse/industrial, mixed-use, retail, medical/healthcare, self-storage, and hotel/motel.

Advantages of Life Insurance Commercial Loans

Life insurance commercial real estate loans have several advantages that make them attractive:

• Fixed Interest Rates: Competitive rates that don't change for the duration of the loan (15 - 30 years).
• Non-Recourse and Assumable: Providing protection for individuals and allowing the loan to be transferred.
• No Limit: Access to large amounts with no official upper limit on the amount borrowed.

Disadvantages of Life Insurance Commercial Loans

However, there are also some disadvantages to life insurance commercial real estate loans:

• Grade A Properties: Often only available for newer, well-maintained properties, and not for older or distressed properties.
• LTV & DSCR Requirements: More conservative Loan-to-Value (LTV) and Debt Service Coverage Ratio (DSCR) requirements that borrowers must meet.
• Prepayment Penalties: Frequently include prepayment penalties and are not offered for shorter terms.

Who Are Life Insurance Commercial Loans Suitable For?

Life insurance commercial real estate loans are suitable for borrowers seeking long-term financing for commercial real estate projects, particularly those with high-quality properties and a good credit history. It's important to note that borrowers typically won't deal directly with the insurer and will need an intermediary with a relationship with the company.

Corporate-owned life insurance (COLI)

COLI differs from a traditional life insurance policy in that the employer buys the plan, owns the policy, pays the premiums, and receives the death benefit after the death of its employee. It is also different from group life insurance as neither the employee nor their heirs benefit from the policy. However, in some instances, the company may agree to share the payout with the insured's family.

COLI is also referred to as company-owned life insurance, dead peasant insurance, and employer-owned life insurance (EOLI).

History of COLI

COLI has existed in one form or another for over 100 years. Its nickname, "dead peasant" insurance, originates in 19th-century Russia, where feudal serfs were bought and sold as property by the rich. Members of the ruling class could "buy" dead serfs who had been counted in previous censuses from their former owners to acquire collateral to obtain loans.

Uses of COLI

Businesses can take out COLIs to:

• Recoup the cost of funding employee benefit programs
• Help cover lost revenue and hiring costs after the insured passes away
• Gain significant tax benefits
• Fund certain types of non-qualified plans, such as split-dollar life insurance policies
• Cover critical employees, such as executives, owners, or partners, through key person insurance
• Fund the buyout of a deceased partner or owner of a business
• Recover the cost of funding various types of employee benefits

Requirements of COLI

A company must show a substantial economic interest or an insurable interest in the employee's life before a COLI contract can be written. In other words, the company must prove that it would suffer a financial loss if the insured employee passed away.

Before a COLI can be enacted, the insured employee must consent to having their life insured. They must:

• Receive written notification from the company stating it will be the beneficiary of the policy and disclosing the coverage amount
• Provide written consent to the company

The employee has the right to refuse, and the company may not retaliate against them.

Tax Implications of COLI

Companies use COLI primarily for tax benefits. The company will receive a tax-free death benefit if the insured employee dies and will have access to a tax-deferred or tax-free cash value account.

The accumulated cash value funds are only taxable if the life policy is surrendered before the insured passes away. Companies can also take out loans against the cash value of the policy and deduct eligible interest on the loan from their taxable income.

However, since COLIs can be exploited for tax purposes, the industry is now heavily regulated. For example, companies cannot use cash value loans to pay the premiums and then deduct the associated loan interest.

To receive a tax-free death benefit, the company must obtain the proper written notification and consent forms, and one of the following criteria must be met:

• The insured employee was a director or received compensation within the top third of the company's personnel
• The insured employee worked for the company within 12 months of the date of their death
• The death benefit is used to secure an ownership share of the company for the insured employee's family, estate, or trust
• The death benefit is paid to the insured employee's family, estate, or trust

Types of life insurance

There are several types of life insurance, each with its own unique features and benefits. Here are the most common types:

Term Life Insurance

Term life insurance is a temporary policy that provides coverage for a specific term, such as 10, 20, or 30 years. It is generally more affordable than permanent life insurance and is best suited for those who only need coverage for a certain period. Term life insurance policies typically have fixed premiums and provide a guaranteed payout if the insured person dies during the policy term.

Whole Life Insurance

Whole life insurance is a type of permanent life insurance that provides coverage for the entire life of the insured, as long as premiums are paid. It often includes a savings component, allowing the policyholder to accumulate cash value over time. Whole life insurance is usually more expensive than term life insurance but offers guaranteed coverage and stable premiums.

Universal Life Insurance

Universal life insurance is another form of permanent life insurance that offers flexibility. Policyholders can adjust their premium payments and benefit values over time. It also includes a savings component, similar to whole life insurance, but with a variable interest rate.

Variable Life Insurance

Variable life insurance is a riskier type of permanent life insurance. It combines a fixed death benefit with a variable cash value component tied to investment performance. The cash value can rise or fall based on the selected investments, offering the potential for higher returns but also carrying greater risk.

Final Expense Life Insurance

Also known as burial or funeral insurance, final expense life insurance is a type of whole life insurance with a smaller death benefit designed to cover end-of-life expenses such as funeral costs and medical bills. It is often more accessible to older individuals or those with pre-existing health conditions.

In addition to these main types, there are other variations, such as group life insurance, credit life insurance, and simplified issue life insurance, which cater to specific needs and circumstances.

Owning life insurance in a corporation

Corporate-owned life insurance (COLI) is an insurance policy where the owner and beneficiary are a corporation, and the insured life is a shareholder or business owner. This type of insurance is used by companies for various purposes and has complex rules and taxation.

Practical Uses of Corporate-Owned Life Insurance

Estate Tax and Equalization

Corporate-owned life insurance can be used to fund estate tax and equalize the value among beneficiaries when shares in a family-owned corporation form a large part of a person's estate.

Loan Protection

Life insurance can also serve as protection for loans, as lenders may require life insurance for key people for the duration of the loan.

Key Person Protection

The death of a shareholder or key person can put financial strain on a company. Life insurance can provide the necessary cash flow to shore up working capital, repay debts, or hire and train a replacement.

Buy-Sell Agreements

Life insurance is often used to fund buy-sell transactions triggered by a shareholder's agreement upon death. The proceeds can be used to redeem shares or paid as a capital dividend to fund a personal purchase of shares from the deceased's estate.

Tax Benefits of Corporate-Owned Life Insurance

The corporation tax rate is typically lower than the personal income tax rate, making it more tax-efficient to buy life insurance with corporate money. Additionally, the proceeds received from a death claim are tax-free, and the business can pay out these proceeds to beneficiaries tax-free through a capital dividend account.

Practical uses for corporate-owned life insurance

Corporate-owned life insurance (COLI) can be used for a variety of purposes and can be structured in many different ways to accomplish different objectives. Here are some practical uses for corporate-owned life insurance:

Estate Tax and Equalization

Corporate-owned life insurance can be used to fund tax liabilities and equalize the value among beneficiaries when shares in a family-owned corporation form a significant part of a person's estate. In such cases, the shares of the family business are typically left to family members involved in the company, while the remaining assets are divided among the other family members. COLI can provide the necessary funds to pay the estate tax and ensure that all beneficiaries receive an equivalent value.

Loan Protection

Life insurance is often required by lenders for small business loans, especially when the loan is personally guaranteed by the owner. In the event of the owner's death, COLI can be used to repay the outstanding debts, protecting the estate from liability. Additionally, having life insurance can improve a business's ability to obtain financing.

Key Person Protection

The death of a key person, such as a shareholder or executive, can cause financial strain and operational disruptions for a company. COLI can provide the necessary cash flow to shore up working capital, repay debts, or hire and train a replacement.

Buy-Sell Agreements

Life insurance is commonly used by private companies to fund buy-sell transactions triggered by a shareholder's agreement upon death. COLI can be used to buy out the shares owned by the deceased shareholder's estate or beneficiaries, allowing the business to continue operating while providing cash to the deceased's beneficiaries.

Tax Benefits

Purchasing life insurance with corporate money can result in tax savings due to the lower corporate tax rate compared to the personal income tax rate. Additionally, the investment component of life insurance allows money to grow tax-free, and the insurance proceeds received from death claims are typically tax-free.

Frequently asked questions