Tips on Borrowing Against Company Owned Life Insurance for Cash Flow Purposes
Company Owned Life Insurance
Also known as COLI, company owned life insurance is more often than not, a demand from one business partner to another, to protect the company if one of the partners dies. The proceeds from the COLI policy can help pay off debts or can be used as a way to grow or expand a business, as well as making the working capital of a business flush.
COLI policies are attractive to companies, in that premiums are paid by the business, and often a company may even choose to take out COLI policies on not just owners and directors, but top managers as well—some COLI policies are taken out without the top manager’s knowledge, with the business as the beneficiary.
Because COLI policies are an investment venue, while they grow in strength, the business can choose tax deferments or tax-free growth as an option. The cash surrender values for COLI polices are not taxed, if utilized when they become available.
Other times, business owners may choose borrowing from company owned life insurance for cash flow purposes–they need to keep the business afloat. Recently, some laws have been changed on what happens if a loan is taken from these policies.
COLI Policy Loans and Cash Flow
Business owners that engage in borrowing from company owned life insurance for cash flow purposes, can face a few challenges:
Loan Premiums – Any COLI loans can be used to actually pay the premiums on the COLI policy, however the interest on those loans is not deductible. Although loan interest was once a tax benefit, it is simply disallowed as of 2003.
Cash Flow Need – If a business is struggling and determines borrowing COLI money is a way to help cash flow problems, this can be a losing situation for any business. Often COLI policies come with restrictions on what loans can be utilized for—cash flow being one of those restrictions on some, but not all, policies.
Payback – When cash flow is low, taking loans from a viable growth source can place a hardship at payback time—if loan payments are not timely, the policy may lapse.
Funding – Often, business will borrow against COLI policies to fund employment plan benefits and while the payments to these various employee benefit plans may be tax deductible, again the loan interest is not.
Insurable Interest
While it is possible to utilize borrowing against company owned life insurance, cash flow needs may not be the only concern a business faces. Businesses that take out COLI policies on key personnel without their knowledge, are looked at as “dead janitor” policies, and many times, if the top employee leaves the company, the premiums are still paid, making a tax deferral or growth benefits essentially illegal and frowned upon by the Internal Revenue Service. Hence, a company must be able to show an “insurable interest” in the employee, prior to taking out these types of insurance policies.
Bottom Line
Experts warn business owners to perform due diligence on any insurance company offering a COLI policy. If there is a downturn in the economy and the insurance company suffers, any growth and tax benefits may be lost.
Before a company considers borrowing against company owned life insurance for cash flow needs, a more prudent idea would be to learn some cash flow management skills. The only real benefit of borrowing from COLI policies is the ability to fund other employee benefits (non-qualified plans).
For partners who invest in a business and sign personal guarantees for loans or equipment, even if the business structure offers personal liability, COLI policies are an effective way to settle debts and loans if one partner dies, as the company, (the beneficiary) of the policy can use the funds (tax free) to pay off such loans and debts.
Finally, all COLI accounting policies should be reviewed by the company’s accountant and perhaps attorney to ensure the business is complying with federal and state tax laws, as well as insurance laws.
References
COLI - Taxes & Insurance (Baird/Marples) 2010 retrieved at https://www.nahu.org/legislative/resources/crs%20COLI%20May%2010.pdf
Accounting for Company-Owned Life Insurance (Nurnberg, Hugo) retrieved at https://business.highbeam.com/3839/article-1G1-135164282/accounting-companyowned-life-insurance
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