Frequently Asked Questions

Employee Ownership FAQs

Common questions about employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), and other forms of employee ownership, from the basics to technical topics.

This FAQ is written primarily for business owners, managers, and advisors involved in setting up or running an employee ownership plan. If you're an employee at an ESOP company looking to understand your own benefits and rights, see our articles on Working at an ESOP Company and The Rights of ESOP Participants.

NCEO employee ownership FAQ hero (keyboard)

What is Corporate Owned Life Insurance (COLI) and is it a good repurchase strategy?

COLI is life insurance owned by the company on the lives of ESOP participants. The company is the beneficiary should the participant die, with the money then used for the repurchase of shares. Premiums paid on COLI policies are not deductible and the death benefits are received tax-free. Meanwhile, the build up in value in the policy is not taxable to the company. The cash value can be borrowed, but for policies issued after June 8, 1997, interest is not deductible unless the insured person is a "key person" (limited to between 5 and 20 persons, depending on the size of the company). In that case, the interest on loans of up to $50,000 may be deductible.

Companies follow two typical strategies in using corporate owned life insurance for repurchase. One option is to insure those people whose accounts are expected to become very large. If these people die before termination, the policies can pay all or part of their distributions. If they do not die before termination, the company pays off the participant at termination, but holds on to the policy until the participant does die. At that point, the life insurance proceeds revert to the company. Over time, this can help create cash flow to fund repurchase.

A second approach is to use the build up in value to develop a sinking fund to pay for repurchase, by borrowing or withdrawing cash value. Because of limits on deductibility of interest on policy loans, this approach is not as attractive as it once was. Whether COLI is a good approach depends in large part on the quality of the investment the insurance carrier provides and the sometimes substantial fees paid in commissions (as much as 90% of the first year's premium). Most insurance company portfolios are based on conservative investments, and carry various ongoing fees, reducing the effective rate of return relative to other investments. Variable life polices, however, can allow more aggressive management, but carry more risk. On the other hand, the life insurance and tax benefits can be significant. The tax benefits provided by the tax free growth of cash value and death benefits can be compared to the expenses of the policy to determine if it is an attractive investment.

Link to this FAQ Topic: Distributions & Repurchase