Life Insurance: When To Include Your Corporation As A Beneficiary

Life insurance is a financial product that provides financial protection to millions of people in America and worldwide. While individuals usually purchase life insurance, companies and institutions also use it for various purposes, such as providing liquidity. Corporate-owned life insurance (COLI) is a type of insurance where the corporation is the owner and beneficiary of the policy, and the insured is the shareholder or business owner. This arrangement allows the corporation to pay the policy premiums and receive the proceeds upon the insured's death. While the premiums are typically non-deductible, they can be financed by corporate dollars, which is more advantageous than using after-tax personal funds. This article will explore the topic of whether a corporation should be the beneficiary of your life insurance policy, examining the benefits, considerations, and potential drawbacks.

Tax benefits

Corporate-owned life insurance (COLI) is a type of insurance that a corporation purchases for its own use. The corporation is listed as the beneficiary on the policy, and an employee or group of employees, an owner, or a debtor is listed as the insured. COLI can be structured in different ways to achieve different objectives.

One common use of COLI is to fund certain types of non-qualified plans, such as a split-dollar life insurance policy. This allows the company to recoup its premium outlay by naming itself as the beneficiary for the amount of the premium paid, with the remainder going to the insured employee.

Another form of COLI is key person life insurance, which pays the company a death benefit upon the death of a key employee. This can provide the company with the cash flow needed to shore up working capital, repay debts, or hire and train a replacement.

In terms of tax benefits, life insurance is generally one of the most tax-advantaged vehicles available. The death benefit from any life policy is typically tax-free for individual and group policies. However, this may not always be the case for policies owned by corporations.

• Tax-Free Death Benefits: While death benefits from corporate-owned life insurance policies are not always tax-free, there are instances where they are. For example, if the insured employee dies while still employed by the company, the death benefit is usually tax-free. Additionally, death benefits paid upon the death of a director or highly compensated employee are also typically exempt from taxation.
• Tax-Deferred Growth: Money placed inside cash value policies by corporations grows tax-deferred, similar to policies held by individuals.
• Premium Financing: While premiums paid on corporate-owned life insurance policies are generally not tax-deductible, they can still be financed using corporate dollars. This means the corporation can pay the premiums without incurring additional tax liability.
• Tax-Free Dividends: Once the insurance proceeds are received, they are typically not taxable to the corporation. An equivalent amount (net of any adjusted cost basis) is added to the company's capital dividend account, which can then be paid out tax-free to shareholders as a capital dividend.
• Estate Tax and Equalization: Corporate-owned life insurance can help with estate tax liabilities and equalizing the value among beneficiaries. The proceeds can be paid to an estate via a capital dividend, funding tax liabilities and providing cash to beneficiaries.
• Loan Protection: Life insurance can improve a business's ability to obtain financing and protect against loan defaults. In the event of the death of a key person, the insurance proceeds can be used to repay debts or continue business operations.
• Buy-Sell Agreements: Life insurance proceeds can facilitate the buyout of a deceased shareholder's shares, helping the business carry on while providing cash to the deceased's beneficiaries.

Estate planning

One of the primary reasons to consider a corporation as a beneficiary is in the context of corporate-owned life insurance (COLI). COLI refers to a life insurance policy where the corporation is the owner and the beneficiary, and the insured is typically a shareholder or a key employee. This type of insurance provides financial protection to the company in the event of the insured's death. It can be used to fund certain types of non-qualified plans, buy-sell agreements, or key person life insurance. By naming itself as the beneficiary, the company can recoup its premium outlay, with the remainder going to the insured's beneficiaries.

Another scenario where a corporation may be named as a beneficiary is when an individual's estate includes shares in a family-owned business. In such cases, corporate-owned life insurance can help facilitate a tax-efficient transfer of assets. The corporation can use the insurance proceeds to pay estate taxes and ensure that all beneficiaries receive their fair share, regardless of their involvement in the company.

It is important to note that tax laws regarding corporate-owned life insurance can be complex and vary across different jurisdictions. Seeking professional advice from financial advisors, tax consultants, and legal experts is essential to ensure compliance with applicable laws and to maximize the benefits of estate planning.

Additionally, it is worth mentioning that life insurance is not just for the benefit of corporations. Individuals can also use life insurance as a tool for estate planning. By designating family members or loved ones as beneficiaries, individuals can provide financial security and support to their dependents after their death. This is especially important if there are minor children or individuals with special needs who may require long-term financial assistance.

In conclusion, while considering a corporation as a beneficiary of life insurance is not a common practice, there are certain situations where it can be advantageous, particularly in the context of corporate-owned life insurance and estate planning involving business assets. However, it is always recommended to seek professional advice to navigate the complex tax laws and ensure that your estate plan aligns with your specific circumstances and objectives.

Key person protection

The company is the beneficiary of the policy and pays the premiums. This type of insurance is essential if the loss of a certain individual would negatively and profoundly affect the company's operations. The death benefit provides the company with financial protection and buys the company time to find a replacement or implement other strategies to save the business.

The money received from the insurance policy can be used to cover the costs of recruiting, hiring, and training a replacement for the deceased. If the company decides not to continue operations, the money can be used to pay off debts, distribute money to investors, provide severance benefits to employees, and close the business in an orderly manner.

Key person insurance is also available as disability coverage in case the individual is incapacitated and can no longer work. This helps safeguard the business and ensures its continued survival.

When determining the amount of key person insurance needed, companies should consider the employee's salary, their contribution to the company's bottom line, and the costs associated with replacing them.

It is important to note that there are tax implications associated with key person insurance. While the death benefits are usually tax-free, there may be income tax on the benefits received. Additionally, premiums for key person insurance are generally not deductible and must be paid with after-tax dollars by the company.

Buy-sell agreements

A buy-sell agreement is a legally binding contract that stipulates how a partner's share of a business may be reassigned if that partner dies or leaves the business. It is also known as a buyout agreement, business will, or business prenup.

There are two common forms of buy-sell agreements:

Cross-Purchase Agreement

In a cross-purchase agreement, the remaining owners or partners purchase the share of the business that is for sale. Each business owner buys a life insurance policy on each of the other owners. When an owner dies, the remaining owners use the payout from the life insurance policy to buy the deceased owner's share of the business.

Entity-Purchase or Stock Redemption Agreement

In an entity-purchase or stock redemption agreement, the business entity itself buys the deceased's share of the business. Each employee-owner enters into an agreement with the business to sell their interest in the business. The business buys life insurance policies on the lives of each owner, pays the premiums, and is the beneficiary of the policy. When an employee-owner dies, that share of the company passes to the heirs of their estate, and the business uses the policy's death benefit to buy the interest from the estate.

Hybrid Approach

A hybrid approach combines elements of both the cross-purchase and entity-purchase agreements. It offers flexibility, allowing either the entity or the surviving owners to buy a deceased owner's interest. The agreement typically requires the owner(s) of the insurance to buy first, with the entity and other owners having the option to purchase any remaining interests.

Loan protection

In small businesses, lenders often require that loans be personally guaranteed by the owner. In some cases, lenders may also require life insurance for key people for the duration of the loan. Even when lenders don’t require life insurance, it’s good practice to have it. A personal guarantee becomes a liability for the guarantor's estate, meaning the estate could be held liable for outstanding debts that the business cannot pay. Having life insurance can also improve a business's ability to obtain financing.

Life insurance can provide a business with the cash flow needed to shore up working capital, repay debts, or provide the funds necessary to hire and train a replacement when a key executive dies. The benefits of the policy can be used to pay off personal loans, car loans, or credit cards.

There are two different types of loan protection insurance policies: the standard policy and the age-related policy. The standard policy disregards the age, sex, occupation, and smoking habits of the policyholder. The policyholder can decide what amount of coverage they want. This type of policy is widely available through loan providers. It does not pay until after the initial 60-day exclusion period. The maximum coverage is 24 months.

Age-related policies, on the other hand, are only offered in Britain. The cost is determined by the age and amount of coverage the policyholder wants to have. The maximum coverage is 12 months. Quotes might be less expensive for younger policyholders because, according to insurance providers, younger policyholders tend to make fewer claims.

Depending on the company providing the insurance, loan protection policies sometimes include a death benefit. For either type of policy, the policyholder pays a monthly premium in return for the security of knowing that the policy will pay when the policyholder is unable to meet loan payments.

Frequently asked questions