Bank Owned Life Insurance. Kirk A. Pelikan

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1 Bank Owned Life Insurance Kirk A. Pelikan

2 BOLI: The Basics BOLI is a life insurance policy purchased by a bank to insure the life of a certain employee. Product has been around since the 80 s. Commonly used to recover losses associated with key person s death, to fund retirement benefits, or to provide a direct retirement benefit.

3 BOLI: The Basics Bank owns the policy and is the beneficiary under the policy. Bank accrues revenue from investment earnings and bears risk of investment loss. Different than split dollar life insurance In split dollar, bank and employee share rights to the policy s cash surrender value and death benefits.

4 BOLI: Benefits Income earned is tax free for the Bank and when the employee dies, the cash payments the company receives are tax free. May result in a higher tax-equivalent yield than is available on securities or loans. BOLI is a long-term play. Shorter periods of time will result in a greater potential to experience a loss.

5 BOLI: Risks Risk that the insurance co. does not remain solvent. Although the death benefit is not taxable to Bank, it is taxable to employee where the insurance is used as funding mechanism for certain benefit plans.

6 Tax Treatment Premiums. Bank's premium payments toward the policies for key-executive insurance are not deductible because the employer is the owner of and a beneficiary of the policy. Deduction Timing. Benefit payments under the Plan (whether or not funded by the BOLI) are deductible when the amounts are includible in the employee's income. This deferred tax treatment creates a timing difference between taxable income and book income for accounting purposes taxable income will exceed book income.

7 Tax Treatment Annual Cash Value Build Up (and AMT). So long as a life insurance contract is life insurance, annual cash value build-ups are generally not income taxable to the policyholder. However, cash value increases in excess of aggregate premiums paid may increase a corporation's Alternative Minimum Tax (AMT) liability. This situation is most likely to occur when small corporations buy large policies. Death Benefits. Death benefits payable to a survivor under the Plan are taxable (under the Code section 72 annuity rules and the Code section 691 rules for income in respect of a decedent). Assuming the corporate alternative minimum tax does not apply, the employer should receive the proceeds of the supporting life insurance policies taxfree upon the employee's death. However, these proceeds do not retain their taxexempt character when death benefits are then paid by the employer to the employee's survivor under the Plan, even if they are paid in a lump sum, because they are actually paid from the corporation's general assets and not from the policy. Note that this summary does not include a discussion of gift and estate tax consequences.

8 Don t Forget About Code 101(j) In 2006, Congress made a major change to requirements to achieve favorable tax treatment of BOLI contracts death proceeds. If requirements not met, the exclusion amount equals the sum of the premiums and other amounts paid for the insurance contract.

9 101(j) Requirements For exception to apply, employee upon whose life the policy is based must: Receive written notice that employer intends to insure the employee s life and of the maximum face amount for which the employee could be insured at the time the contract was issued; Consent in writing to being insured under the contract and continuation of the coverage after the insured terminates employment; and Receive written notice that policyholder will be a beneficiary of proceeds payable upon the employee s death. Consent must be obtained before the issuance of the policy.

10 101(j) Corrections There is no provision for correcting an inadvertent failure to satisfy the notice and consent requirements. Exception: if procedures were in place and the failure to give notice and obtain consent was inadvertent, a correction can be made as long as it is done before the tax return is filed for the year in which the policy was issued. In no event can a correction be made after the insured dies

11 Annual Reporting Requirements Every policyholder owing BOLI contracts issued after August 17, 2006, must, for tax years beginning after November 13, 2007, file IRS Form 8925 with the policyholder s income tax return, showing for each year that the contracts are owned: The number of employees of the policyholder at the end of the year; The number of employees insured under the BOLI contracts at the end of the year; The total amount of insurance in force at the end of the year under all those contracts; The name, address, and TIN of the applicable policyholder, and the policyholder s type of business; and Certification that the policyholder has a valid consent for each insured employee (or disclosure of those for whom consent was not obtained).

12 Final Thoughts Bank Owned Life Insurance is a long term play. Employers purchase it with the intent that it will be there through the date the executive turns 65. Shorter lengths of time can result in losses, unless the executive dies. If a Bank is not comfortable purchasing a long-term asset, then a BOLI program may not be suitable. Accounting for BOLI: The monthly policy income is booked as noninterest income. If a Bank is not profitable or has liquidity issues, a BOLI purchase may be inappropriate.

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14 BANK OWNED LIFE INSURANCE Kirk A. Pelikan michaelbest.com