Benefits of Using Corporate-Owned Life Insurance (COLI) to Fund Nonqualified Plans

Offering nonqualified deferred compensation (NQDC) savings plans as a supplement to traditional qualified plans such as a 401(k) is an effective tool companies use to attract, motivate, and retain key employees, and to help resolve qualified plan testing failures. But because NQDC plans do not meet ERISA requirements, they must be funded differently than qualified plans.

Mutual funds have often been the most common method chosen to informally fund NQDC plans, but there are other options. One of those alternative funding methods is corporate-owned life insurance (COLI). In fact, 63% of firms who have NQDCs use COLI as an informal funding vehicle*. 

Benefits of COLI for NQDC plans

With COLI, the company offering the NQDC purchases and owns a life insurance policy on a key employee and is the primary beneficiary. The corporation pays non-deductible premiums, receives tax-deferred cash values, and receives tax-free death benefit proceeds.

Many companies that offer NQDC plans for their highly compensated employees choose to fund these plans with COLI to hedge their deferred compensation liability and to reduce some of the statement volatility associated with other funding vehicles, including mutual funds. Over the long-term, COLI programs can help increase benefit security and help reduce overall plan costs, potentially delivering more value to participants.

Potential Tax Advantages of Funding Nonqualified Plans with COLI

Since the cash value of the COLI policy is not subject to taxation during the accumulation period—or the period during which the premiums are paid—the company does not need to pay the income tax costs incurred.   The full interest or gain remains within the asset and enjoys the benefits of tax-deferred growth and/or compound returns. 

Why advisors should consider adding COLI offerings

Adding COLI programs to your suite of services can help grow your business in many ways, as COLI usage as a funding option for benefit plans is quite prevalent, as many Fortune 1000 companies use COLI as a funding tool.

Offering COLI programs can help advisors:

• Re-engage with existing clients who already have NQDCs
• Expand their business by offering a product many other advisors do not
• Offer clients a tax-advantaged, cost-effective funding solution
• Offer clients a tax-deferred asset that they own
• Provide clients with a hedge against the liabilities that come with offering NQDCs

COLI programs also give companies the flexibility to allow the program’s investment performance to loosely match the investment allocation selected by participants by utilizing variable life insurance products, with the investment choices potentially mirroring the returns of the funds offered within the variable products.

Five Key Takeaways

1. COLI can help reduce taxes on invested assets, potentially increasing after-tax returns for the company and enhancing shareholder value
2. COLI death benefits can be used to help the company recover plan costs over the long term
3. The income tax advantages over other funding vehicles make COLI programs a highly attractive option for many companies. The benefits include tax-deferred growth of cash value; tax-free reallocation within the policy; and tax-free receipt of death proceeds.
4. COLI can provide enhanced cash flow flexibility through the employer's access to the cash value via policy loans and policy withdrawals
5. COLI receives favorable accounting and profit-and-loss treatment, relative to taxable investments, on company balance sheets

Addressing common misconceptions about COLI programs 

While COLI is used as a funding source by numerous large, name-brand companies, there are still some reservations and misconceptions about these policies in the marketplace, including:

• There is too much legwork involved. Companies must carefully review the financial strength of each potential insurance carrier, given that the financial capabilities and reputation of the carrier are critical to the future viability and credibility of a COLI program.
• They are too intrusive. A common misconception is that insurers will require the insured employees to pass a physical or take other medical tests.
• The policies are too difficult to set up and administer.

However, working with the right COLI provider can counter these and many other reservations and misconceptions companies may have. When offering COLI to your clients, choose a provider that:

• Is well-versed in every kind of COLI policy, partners with insurance carriers of all types, and conducts comprehensive reviews of each carrier to ensure it has the capability, including the financial strength, to take on the business, thus doing the legwork instead of the company
• Partners with “guaranteed issue” insurers that do not require physicals or other medical tests
• Has in-depth knowledge of the COLI landscape and will simplify the process by working with you, and your clients, from start to finish, including handling the administration and servicing of the program

Comprehensive COLI services and expertise 

Newport, an Ascensus company, has been in the COLI business for decades and knows the landscape inside and out. We offer a comprehensive platform designed to provide clients with a full range of services to help them optimize their COLI program and improve their hedging strategies. Advisors and clients alike can rely on our COLI professionals, consisting of more than 100 specialists, to provide expertise throughout the entire COLI lifecycle.

Newport’s COLI programs offer several key features that help us stand out from the crowd, including: 

• Independence: We set up and administer the plans, but are not an asset manager
• A long-term commitment: We work with you throughout the entire process, and carry on working with your client until the end of the policy
• A vast array of large insurance partners: We partner with some of the largest, “guaranteed issue” insurers in the world offering all types of flexible policies

If you’re interested in exploring the possibility of adding a COLI offering to your suite of services, we would love to hear from you. Contact us today.

* Newport/PLANSPONSOR NQDC Trends Survey Report (employer survey on NQDC plans); https://www.ascensus.com/solutions/nonqualified/nqdc-survey-report/