Hitch long-term obligations to capital for greater tax efficiency 

by Sam Barnett

Look, life insurance IS a protection product, no argument there. So when it powers a COLI strategy, folks naturally file the whole thing under “protection.” And honestly, that’s not wrong. But here’s the question I’d ask: protection from what? An untimely death? Or from success? 

Yes, COLI can address real business risks: key-person exposure, employee retention, buy-sell obligations, deferred comp. It makes total sense, because those promises run long, and permanent life insurance is also built for the long haul. And when properly structured, the death benefit can provide an important source of liquidity when a business needs it most. Framed that way, COLI looks like mortality protection, plain and simple. 

But flip it around. A lot of successful companies have a different problem that doesn’t get nearly as much attention: they’ve accumulated substantial amounts of after-tax capital, and they need to figure out what to do with it. That’s not a mortality problem. That’s a “we won and now we’ve got to deal with it” problem.  

Not your average COLI

That’s where COLI stops looking like a premium obligation and and more like a component of a broader capital-management strategy. A business with significant retained earnings may have long-term obligations already on the books, or obligations it expects to knock out in the future: Buy-sell, deferred comp, employee retention, and key-person needs. The question is, how do they plan to fund those obligations? 

For some businesses, properly-structured permanent life insurance can provide a combination of protection, cash-value accumulation and potential liquidity. Cash value generally accumulates on a tax-deferred basis, and policy values may, when properly structured and managed, be accessed through withdrawals and policy loans with potentially favorable tax treatment. 

That’s an important distinction: potentially-favorable tax treatment isn’t the same thing as tax-free money under every circumstance. Policy design, funding, distributions, loans and the policy’s ability to remain in force all matter. So does ongoing management. When the strategy is designed around the business’s actual needs, the policy can transcend just the death-benefit to become one element of a long-term plan for managing capital and funding future obligations.  

The bottom line

Here’s the truth about most buy-sell agreements, deferred comp plans, and retention packages: they’re not liabilities sitting around waiting for a tragedy to happen. They’re promises the business made to itself back when it was heads down, fighting to grow and win, and then, because the timeline was long and easy to put off, probably never got funded. 

And when you’re sitting across from a successful business owner, “what happens if you die” is an easy question to answer. “What have you actually done with capital you’ve accumulated to fund obligations you’ve already made,” tends to get a little more uncomfortable. 

Advisors and agents don’t need to talk their clients into staring down their own mortality. Instead, help them make thoughtful use of their capital while preparing for the obligations that come with success. This is something they may have deferred because it doesn’t feel urgent until a partner dies, or a deferred comp bill comes due, or their best person gets poached by the competitor down the street.