Corporate-Owned Life Insurance (COLI): When the Need Ends

What COLI Is and Why Companies Buy It

Corporate-owned life insurance is coverage a business purchases on the life of an employee — usually an executive or owner — with the company as both owner and beneficiary. The insured person’s family typically receives nothing from the policy itself; the business is protecting or funding its own interests. Common purposes include:

• Key person protection — replacing profits and recruiting costs if a critical executive dies. (See key person insurance options for that use case in depth.)
• Funding buy-sell obligations — providing cash for the company or co-owners to purchase a deceased owner’s shares under a buy-sell agreement.
• Informally funding executive benefits — supporting nonqualified deferred compensation, supplemental retirement plans, and split-dollar arrangements, where the policy’s cash value grows tax-deferred on the corporate balance sheet.
• Bank-owned life insurance (BOLI) — the banking industry’s version, used to offset employee benefit costs.

Permanent products — whole life, universal life, and variable universal life — dominate COLI because the cash value accumulation is part of the design. That cash value is a corporate asset, carried on the books, and it is exactly what makes the “what now?” question worth real money when the underlying need ends. A policy bought fifteen years ago to protect against the founder’s death does not evaporate when the founder retires; it sits there consuming premium or quietly draining its own cash value to cover charges.

The Tax Rules That Shape Every COLI Decision

COLI lives inside a specific tax framework, and every exit option is priced by it.

Death benefits and IRC 101(j). Life insurance death benefits are generally income-tax-free, but for employer-owned contracts issued after August 17, 2006, Section 101(j) makes the death benefit taxable to the employer above premiums paid unless the company satisfied notice-and-consent requirements before issue and the insured fit an exception (directors, highly compensated employees, or certain others). The insured must have been given written notice that the company would own the policy and could continue coverage after employment ends, and must have consented in writing. Companies also file Form 8925 annually with the IRS to report employer-owned contracts. A COLI file missing its notice-and-consent paperwork is a genuine problem to surface before choosing an exit.

Cash value growth. Inside build-up is tax-deferred, and this is a major reason companies hold mature COLI. Surrender ends the deferral and triggers ordinary income on gain.

Premiums are not deductible. Under IRC 264, a business cannot deduct premiums on a policy in which it is a beneficiary, and interest deductions on loans against COLI are sharply limited.

Transfer-for-value. IRC 101(a)(2) can strip the death benefit’s tax-free character when a policy is sold or transferred for consideration, subject to important exceptions — including transfers to the insured personally and transfers to a partner of the insured. The 2017 tax act added “reportable policy sale” rules that tightened this area further. Any transfer or sale of COLI should be run past tax counsel with these provisions on the table.

When the Need Ends: The Five Realistic Paths

Business needs for coverage end in predictable ways: the key executive retires or departs, the company is sold and the acquirer has no use for the policy, a buy-sell agreement is restructured or the partner bought out, a deferred compensation plan is terminated or settled, or the company simply outgrows the risk the policy covered. At that point the options are:

• Keep the policy. If it is well-funded and the insured is older, the internal rate of return to maturity can be attractive purely as a corporate asset. This is a real choice, not a default — it requires an in-force illustration and someone accountable for monitoring it.
• Surrender for cash value. Immediate liquidity; gain above basis is ordinary income to the corporation; all future death benefit is forfeited.
• Let it lapse. Stop paying and walk away. This is the worst outcome whenever the policy has cash value or the insured’s health has declined, because both of the value-recovering alternatives below are lost.
• Transfer or sell to the insured (or their trust). Common for departing executives who want the coverage personally. The transfer is generally taxable compensation or a sale at fair market value, and the transfer-to-insured exception usually protects the death benefit from transfer-for-value taint.
• Sell to an institutional buyer in a life settlement. If the insured is older or has health impairments, licensed providers may pay substantially more than the surrender value — per the GAO’s study of the secondary market, settlements have historically paid multiples of cash surrender value for policies that qualify.

Businesses weighing that last path can start with how life settlements work for business owners.

Surrender vs. Settlement: Running the Corporate Numbers

For a company, the surrender-versus-settlement comparison is a straightforward asset-disposition analysis — the same discipline applied to selling equipment or real estate, applied to an insurance contract.

Surrender returns the cash surrender value, minus any surrender charges still in effect, with gain over the company’s basis taxed as ordinary corporate income. It is fast and administratively simple.

A life settlement is a sale of the policy to a licensed provider backed by institutional capital. Pricing is a discounted-cash-flow calculation on the insured’s life expectancy: buyers commission independent LE reports, project the premiums they will pay, and discount the death benefit accordingly. Settlements typically pay 10–35% of face value and typically 4–8 times cash surrender value for policies that qualify — generally insureds 65 or older (younger with significant health impairments), face amounts of $100,000 and up, and policies in force at least two years. The process runs 60–120 days, with two independent life expectancy reports taking 2–6 weeks and escrow protecting funds at closing. The mechanics of pricing are covered in how life settlement value is calculated, and the head-to-head decision in life settlement vs. surrender.

The corporate wrinkle: the entity, not an individual, is the seller, so the transaction requires corporate authorization, and the tax result follows the same three-tier structure described in IRS Rev. Rul. 2009-13 as modified by the 2017 tax act — proceeds up to basis tax-free, basis to cash value as ordinary income, the excess as capital gain. Where the numbers land depends on how long the company funded the contract, so an in-force illustration and a basis calculation are the first two documents to pull.

Exit Option	Company Receives	Tax Consequence	Best Fit
Keep the policy	Death benefit at maturity; ongoing cash value growth	Tax-deferred build-up; death benefit tax-free if 101(j) requirements met	Well-funded policy, older insured, company can hold long-term
Surrender	Cash surrender value, less any charges	Gain over basis taxed as ordinary corporate income	Company needs liquidity now; policy would not attract market offers
Lapse	Nothing	Possible taxable gain if loans exceed basis	Almost never — value-destroying default
Transfer/sell to insured	Sale price, or compensation deduction if distributed	FMV is compensation or sale proceeds; transfer-to-insured exception preserves tax-free death benefit	Departing executive wants coverage for personal/estate planning
Life settlement	Market offer — typically 10–35% of face, often 4–8× surrender value (GAO-10-775)	Three-tier treatment: basis tax-free; basis→CSV ordinary income; excess capital gain	Insured 65+ or health-impaired; face $100k+; policy unneeded

Transferring the Policy to the Departing Executive

When an executive retires and wants to keep the coverage for personal or estate planning, the company can distribute or sell the policy to them. Done correctly, this converts an orphaned corporate asset into a valued piece of the executive’s personal plan. Done casually, it creates tax surprises on both sides.

Valuation first. The transfer must be priced at the policy’s fair market value — typically approximated by the interpolated terminal reserve or the amount determined under the IRS safe-harbor guidance — not simply the cash surrender value, which can understate a policy on an impaired life.

Tax character. If the company hands the policy over as part of a severance or retirement package, the fair market value is compensation: deductible to the company, ordinary income to the executive. If the executive buys it for full value, there is no compensation event, and the company recognizes gain to the extent the price exceeds its basis.

Transfer-for-value safety. A sale to the insured personally falls within a statutory exception, preserving the income-tax-free death benefit for the executive’s heirs. A transfer to the executive’s irrevocable life insurance trust requires more careful structuring — often the trust is drafted as a grantor trust so the transfer is treated as one to the insured.

Split-dollar unwinds. Policies inside collateral-assignment or endorsement split-dollar arrangements have their own termination rules, and the accumulated economic benefit or loan balance must be reconciled at rollout. The executive who receives the policy then faces their own keep-surrender-or-sell decision down the road, this time as an individual owner.

COLI in a Business Sale: Diligence and Cleanup

Mergers and acquisitions are the single most common moment COLI turns from asset into orphan. The acquirer inherits policies on executives it may never have met, buy-sell coverage for a shareholder agreement that no longer exists, and benefit-funding contracts for plans it intends to terminate. Several diligence and cleanup points matter.

Inventory and paperwork. Sellers should assemble every in-force policy, its ownership and beneficiary structure, current in-force illustrations, the 101(j) notice-and-consent records, and Form 8925 filings. Missing consent paperwork on post-2006 contracts is a diligence flag because it can convert a tax-free death benefit into taxable income for the owner.

Who keeps what. Policies on selling shareholders are frequently distributed to those shareholders at closing as part of the consideration, using the transfer-to-insured exception. Policies funding a deferred compensation arrangement may need to stay with the obligation or be liquidated to settle it.

Stranded value. Policies nobody wants are where settlements earn their place in the checklist. An insured former owner in their seventies with a health history can make a policy worth several times its surrender value to institutional buyers, and that difference belongs to the shareholders if someone captures it before lapse. State regulation matters here: transactions run through licensed providers and brokers under state life settlement acts, with the NAIC’s Life Settlements Model Act as the national framework. Businesses in New Jersey operate under the state’s viatical settlement statute administered by NJ DOBI, which licenses the intermediaries involved.

Governance: Who Should Own the COLI Decision

The most common COLI failure is not a bad decision — it is no decision. Policies purchased under a prior CFO, for an executive who left in a prior decade, keep drafting premium payments or silently consuming cash value because no one on the current team owns them. A modest governance routine prevents this.

• Maintain a policy register. Every corporate-owned contract, its insured, purpose, carrier, face amount, cash value, premium mode, and the business reason it exists. Review it annually alongside the insurance renewal cycle.
• Order in-force illustrations every one to two years. Universal life policies in particular can be quietly underfunded; an illustration shows whether the policy is on track to lapse and what it costs to fix.
• Tie each policy to a live business purpose. When the purpose column goes blank — executive departed, agreement terminated, loan repaid — the policy moves to an active disposition analysis with a deadline.
• Document the decision. Whether the board keeps, surrenders, transfers, or sells the policy, minutes should reflect the analysis. For sales, competitive bidding through licensed channels is the fiduciary-friendly approach, for the same reasons spelled out for trust fiduciaries in life settlements for trustees.
• Confirm insured cooperation early. A settlement requires the insured’s medical records and authorization. A former executive on good terms usually cooperates; a contentious departure can close that door, which argues for resolving policy disposition as part of separation agreements.

None of this is burdensome, and it converts COLI from a forgotten line item into a managed corporate asset.

Honest Downsides and When Keeping the Policy Wins

An educational treatment has to be candid: selling or surrendering COLI is frequently the wrong move, and the alternatives deserve equal airtime.

Mature policies can be excellent hold assets. A policy on an older insured with level premiums and substantial cash value may deliver a strong internal rate of return to the corporation at maturity, uncorrelated with the operating business. Institutional investors buy these policies for exactly that reason — which is a hint that the current owner should at least price the hold option before selling it to someone else.

Settlement downsides are real. The company gives up the entire death benefit, transaction costs and broker commissions reduce net proceeds, the insured’s medical information is shared with buyers under privacy safeguards, and proceeds above basis are taxable. If the insured is young and healthy, offers may not exceed surrender value at all — settlements concentrate their advantage where age or impaired health shortens life expectancy. No outcome is guaranteed, and offers vary meaningfully between providers, which is why competitive bidding matters.

A 1035 exchange may fit better than an exit. If the company still wants an insurance asset but the current contract is inefficient — high charges, an underperforming carrier — a tax-free exchange under Section 1035 into a better contract preserves deferral. The mechanics are covered in the 1035 exchange, step by step.

Tax modeling is not optional. Between corporate rates, basis history, 101(j) status, and the three-tier settlement treatment described in the life settlement tax guide, the after-tax ranking of the five options can flip on facts. The right sequence is: in-force illustration, basis calculation, market pricing, then decision — in that order.

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Frequently Asked Questions

What happens to corporate-owned life insurance when the employee leaves the company?

Nothing automatic — the company still owns the policy and can keep it in force, since insurable interest is measured at issue, not continuously. The realistic choices are keeping the policy as a corporate asset, surrendering it for cash value, transferring or selling it to the departing employee at fair market value, or selling it to a licensed provider in a life settlement if the insured’s age and health make it marketable. Letting it silently lapse is the common default and usually the worst outcome, because it abandons both surrender value and any settlement value.

Can a company sell a COLI policy in a life settlement?

Yes. A corporation that owns a policy can sell it to a licensed life settlement provider the same way an individual owner can, subject to state life settlement laws and the insured’s cooperation with medical authorizations. Marketability follows the usual criteria: insured generally 65 or older or with health impairments, face value generally $100,000 or more, and a policy in force at least two years. Offers, when made, have historically run well above cash surrender value for qualifying policies — the GAO documented typical multiples of 4–8 times surrender value. The company needs board authorization and tax advice, since gain above basis is taxable.

Is the death benefit on employer-owned life insurance taxable?

It can be. For employer-owned contracts issued after August 17, 2006, IRC Section 101(j) taxes the death benefit above premiums paid unless the employer met written notice-and-consent requirements before issuance and the insured fell within an exception, such as being a director or highly compensated employee. Employers must also report covered contracts annually on IRS Form 8925. Policies with clean 101(j) paperwork retain the traditional income-tax-free death benefit. This is why locating the original notice and consent forms is an early diligence step whenever COLI is reviewed, transferred, or kept after an executive departs.

How is a company taxed when it surrenders a corporate-owned life insurance policy?

The company recognizes ordinary income on the amount by which the surrender proceeds exceed its basis in the contract — generally cumulative premiums paid, adjusted for any prior withdrawals or dividends. There is no capital gain treatment on a surrender; the entire gain is ordinary. If the policy carries a loan, the loan balance is treated as part of the amount realized, which can produce taxable income even when little cash actually arrives. Comparing this result to the three-tier tax treatment of a life settlement is a core part of the disposition analysis.

Can a business transfer a life insurance policy to the insured executive without tax problems?

It can be done cleanly, but it is a taxable event that must be priced at fair market value. If the policy is given as part of a retirement or severance package, its fair market value is compensation — deductible to the company and ordinary income to the executive. If the executive purchases it for full value, the company recognizes gain over basis instead. Critically, a transfer to the insured fits a statutory exception to the transfer-for-value rule, so the death benefit generally remains income-tax-free in the executive’s hands. Transfers to trusts need extra structuring to preserve that result.

What is the difference between COLI and key person insurance?

Key person insurance is a purpose; COLI is an ownership structure. Key person coverage is life insurance a business buys on a critical employee to protect against the financial loss of their death — and it is one of the most common forms of corporate-owned life insurance. But COLI also includes policies bought to informally fund deferred compensation plans, support split-dollar arrangements, finance buy-sell obligations, and offset benefit liabilities (banks call their version BOLI). All share the same skeleton: the company owns the policy, pays the premiums, and is the beneficiary, with the tax rules of employer-owned contracts applying across the board.

Should a company do a 1035 exchange instead of surrendering an old COLI policy?

Sometimes. A Section 1035 exchange lets the company move the cash value into a new life insurance or annuity contract without triggering current tax on the gain, preserving deferral. It makes sense when the business still wants an insurance or annuity asset but the existing contract has high internal charges, a weakened carrier, or an outdated design. It does not make sense when the company simply wants out — an exchange continues the commitment, often with new surrender-charge schedules. The decision should be made after comparing surrender, exchange, and settlement values side by side on an after-tax basis.

What should an acquirer look for in COLI due diligence during a business sale?

Five things: a complete inventory of in-force corporate-owned policies with current illustrations; ownership and beneficiary confirmations from the carriers; the Section 101(j) notice-and-consent files for any contract issued after August 2006, plus Form 8925 filings; any split-dollar or deferred compensation agreements tied to the policies; and outstanding policy loans. The buyer and seller should then decide policy-by-policy what transfers, what is distributed to selling shareholders, and what gets surrendered or sold in a settlement. Unresolved policies routinely become orphans that lapse post-closing, destroying value that belonged to someone.

Related Reading

• Key Person Insurance Options
• Buy Sell Agreement Life Insurance
• Life Settlements Small Business Owners
• Deferred Compensation Life Insurance

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Pine Lake Life Solutions does not purchase life insurance policies and does not provide legal, tax, or investment advice. Information provided is for educational purposes only. Eligibility for any option, including life settlements, is not guaranteed and depends on individual circumstances, policy terms, underwriting, and market conditions. Consult independent legal, tax, or financial professionals before making decisions regarding a life insurance policy.