Corporate Owned Life Insurance Requirements (2026)

If your company owns a life insurance policy on an employee, you already know it’s not a simple product. Corporate owned life insurance (COLI) comes with real regulatory requirements, and getting any of them wrong can turn a valuable business tool into a tax nightmare. The rules have tightened over the years, and staying compliant in 2026 means understanding exactly what’s required before, during, and after the policy is issued.

At Insurance By Heroes, we work with businesses navigating these exact situations every day. Our agency was founded by a former first responder and military spouse, and our team brings backgrounds in military service, law enforcement, fire, EMS, healthcare, and education. That public service mindset shapes how we approach every client relationship. We believe in doing things the right way, not the fast way. And because we’re an independent agency, we’re not locked into one insurance company’s products. We shop dozens of carriers to find the right COLI structure and the best pricing for your business.

That distinction matters more than most business owners realize, especially with COLI policies where carrier selection affects everything from underwriting flexibility to cash value performance.

What Corporate Owned Life Insurance Actually Is

COLI is a life insurance policy purchased by a business on the life of an employee, where the company is the owner and beneficiary. Businesses use COLI to fund employee benefits, offset the cost of key person losses, or build cash value on the balance sheet. The policy stays with the company, not the employee.

But COLI isn’t just “buying a life insurance policy with a business name on it.” There are specific legal requirements that separate a legitimate, tax advantaged COLI program from one that the IRS will tear apart. Let’s walk through them.

The Consent Requirement

This is the single most important compliance rule. Under federal law (the Pension Protection Act of 2006), the insured employee must provide written consent before the policy is issued. No exceptions.

The consent must include notification that the employer intends to insure the employee’s life. The employee must be told the maximum face amount they could be insured for. And the employee must be informed that the employer will be the beneficiary of the death benefit.

Skipping this step, or doing it sloppily, doesn’t just create a legal headache. It can disqualify the entire death benefit from tax free treatment. That means the full payout could become taxable income to the business. On a large policy, that’s a devastating financial hit.

Keep signed consent forms on file permanently. If there’s ever an audit or a claim, you’ll need to produce them.

The “Legitimate Employee” Rule

Not just anyone qualifies as an insured under COLI. The IRS restricts which employees can be covered, and these rules are strict. The insured must fall into one of these categories at the time the policy is issued.

They must be a director, a highly compensated employee (earning above the IRS threshold, which for 2026 is worth confirming with your tax advisor), or among the top 35% of employees by compensation. Alternatively, the employee must have given their consent as described above AND be an employee at the time of issuance.

Insuring rank and file employees broadly used to be common. The so called “janitor’s insurance” scandals of the 1990s led directly to the rules we have today. If your business is insuring a large number of employees, make sure every single one meets the eligibility criteria. Getting this wrong on even one policy can trigger problems across the entire COLI program.

Tax Compliance and the Modified Endowment Contract Trap

COLI policies are typically permanent life insurance, often whole life or indexed universal life. That means they build cash value over time. And that cash value grows tax deferred, which is one of the main reasons businesses buy COLI in the first place.

But there’s a catch. If premiums are paid too aggressively, the policy can become classified as a modified endowment contract (MEC). When that happens, the tax advantages of accessing cash value change dramatically. Withdrawals and loans from a MEC are taxed on a last in, first out basis, meaning gains come out first and get taxed as ordinary income. There’s also a 10% penalty on distributions taken before the insured reaches age 59 and a half.

Your insurance carrier should track MEC limits, but the business owner is ultimately responsible for making sure premium payments don’t push the policy over the line. This is especially relevant if your company makes large upfront premium payments to accelerate cash value growth.

Why Carrier Selection Matters More Than You Think

Here’s something most business owners don’t realize about the insurance industry. A captive agent, someone who works for one specific insurance company, can only offer you that company’s COLI product. If that carrier’s underwriting is unfavorable for your industry, your employee demographics, or your funding strategy, you’re stuck.

An independent agency like Insurance By Heroes works differently. We have relationships with dozens of carriers, and every single one of them prices risk differently. The same 52 year old executive might get a Preferred rating from one carrier and a Standard rating from another. On a million dollar COLI policy, that difference in rating class can mean tens of thousands of dollars in premium over the life of the policy.

This isn’t a small detail. It’s the difference between a COLI program that performs as projected and one that drains more cash than it should. When you’re ready to see actual rates for your specific situation, the quickest way to start is by clicking the quote button on this page. You’ll get real numbers from multiple carriers, not a single company’s take it or leave it offer.

Managing Your COLI Policy After Purchase

Buying the policy is step one. Managing it properly is everything that follows, and it’s where many businesses drop the ball.

Beneficiary Designations

The company is typically both owner and beneficiary on a COLI policy. But if the business structure changes (mergers, acquisitions, entity restructuring), the beneficiary designation needs to be updated. A policy that lists “ABC Corp” as beneficiary won’t pay cleanly if ABC Corp has merged into “XYZ Holdings” and no one updated the paperwork.

Review beneficiary designations annually and after any corporate restructuring event.

Policy Loans and Cash Value Access

One of the advantages of COLI is the ability to borrow against the accumulated cash value. These loans don’t require credit checks or approval processes. But there are important things to understand.

Outstanding loans reduce the death benefit dollar for dollar. If your company borrowed $200,000 against a $1 million policy and the insured passes away, the payout is $800,000. Interest accrues on policy loans, and if it’s not managed, it can erode the cash value to the point where the policy lapses. A lapsed COLI policy with outstanding loans can trigger a taxable event.

Annual Reporting Requirements

Businesses that own COLI policies must report them on their tax returns. For most companies, this means including COLI related information on the relevant corporate tax forms. The IRS requires reporting of policies owned, premiums paid, and death benefits received. Failure to report can result in penalties of $10,000 per policy per year.

This is one of those areas where working with both a knowledgeable insurance professional and a CPA familiar with COLI makes a real difference.

Understanding Key Riders on COLI Policies

COLI policies often come with riders that can add significant value if you know how to use them.

An accelerated death benefit rider allows the business to access a portion of the death benefit if the insured is diagnosed with a terminal illness. A waiver of premium rider keeps the policy in force if the insured becomes disabled and can’t work. Some carriers offer chronic illness riders that provide access to funds if the insured needs long term care.

Not every carrier offers the same riders, and pricing varies widely. This is another area where comparing multiple carriers through an independent agency saves real money.

The Claims Process for COLI

When an insured employee passes away, the business files the claim. The process is straightforward but requires proper documentation.

You’ll need to notify the insurance company, submit a certified death certificate, and provide proof that the claimant (the business) is the rightful beneficiary. Most carriers process COLI claims within two to four weeks.

One critical detail. If the death occurs within the first two years of the policy (the contestability period), the carrier has the right to investigate the application for material misrepresentation. This is why accuracy on the original application matters so much. Overstating an employee’s health, understating tobacco use, or omitting medical history can give the carrier grounds to deny or reduce the claim years later.

The Cost of Waiting

Every year you delay purchasing or restructuring a COLI policy, the insured employees get older. And age is the single biggest premium driver in life insurance. A policy on a 45 year old executive costs meaningfully less than the same policy at 47 or 50. Health conditions can also develop or worsen, pushing the insured into a less favorable rating class.

The math is simple. Locking in a rate while the insured is younger and healthier saves the business money for every year the policy remains in force. Getting quotes now gives you real numbers to work with instead of guesswork.

Frequently Asked Questions

Do employees have to be told the company has a COLI policy on them? Yes. Federal law requires written notice and consent from the employee before the policy is issued. The employee must be told that the company will own the policy and receive the death benefit. Without this consent, the death benefit may lose its tax free status.

Can a business borrow from a COLI policy without tax consequences? Generally, yes. Policy loans from a non MEC COLI policy are not taxable events as long as the policy remains in force. However, if the policy lapses with an outstanding loan balance, the loan amount can become taxable. Managing loan balances and keeping the policy funded properly is essential.

What happens to a COLI policy if the insured employee leaves the company? The company retains ownership of the policy. The business can continue paying premiums, surrender the policy for its cash value, or in some cases do a 1035 exchange into a new policy on a different employee. There’s no requirement to transfer or cancel the policy just because the employee leaves.

How many carriers should a business compare when buying COLI? As many as possible. Different carriers price industry risk, health conditions, and cash value accumulation very differently. Comparing quotes from a dozen or more carriers through an independent agency is the most reliable way to find the best combination of price and policy performance. The quote button on this page is the fastest way to start that comparison.