A three-year legislative journey has ended. As part of the pension reform bill signed into law by President Bush on Aug. 17, Congress has enacted provisions conforming the statutory tax rules governing bank-owned life insurance (also referred to as corporate-owned life insurance) to the model the industry uses today.
The enactment of BOLI "best practices" legislation as part of the Pension Protection Act of 2006 concluded a review of employer-owned life insurance by lawmakers that began in 2003.
Significantly, the new law codifies insurance industry best practices for the use of such insurance, and it maintains the income-tax-free treatment of BOLI death benefits if certain requirements are satisfied.
These rules are found in the new section 101(j) of the Internal Revenue Code, and they generally apply to policies issued after Aug. 17, 2006.
In short, the new law permits an employer to receive BOLI death benefit proceeds tax-free when the coverage is for directors or "highly compensated" employees who have given advance written consent and received certain notifications. Most banks already obtain such consent in conjunction with their BOLI purchases to comply with state insurable interest requirements and, importantly, with guidance from the Office of the Comptroller of the Currency. This step is now being incorporated into federal law.
The law's notice and consent provisions require that, before a BOLI contract's issuance, the employee be notified in writing that the bank intends to insure the employee's life and will be a beneficiary of any death benefits.
The notice must also set forth the maximum face amount for which the employee could be insured at the time the contract was issued.
The employee must then provide written consent to being insured under the contract, and to the coverage continuing after the employee terminates employment.
Assuming these notice and consent requirements have been satisfied, BOLI death benefits will be received tax-free if the employee belonged to the law's permitted categories.
The most relevant category is directors and "highly compensated" employees. The "highly compensated" category includes the five highest-paid officers and the highest paid 35% of all employees. For those who entered BOLI contracts in 2006, the category also includes employees who received 2005 compensation of over $95,000. (The figure will be adjusted in future years for inflation.)
The law also requires banks to file an annual return with the IRS for BOLI contracts issued after Aug. 17, showing, among other things, the number of employees insured and the amount of insurance in force under such contracts at the end of the year.
As noted above, the rules generally apply to contracts issued after Aug. 17. However, they do not apply to contracts issued pursuant to a section 1035 exchange for a contract issued on or before that date. And any material change, such as an increase in the death benefit, will generally cause the contract to be treated as a new one.
The enactment of the BOLI best practices legislation is a major victory for banks and their employees. Banks can continue to use the policies to finance employee benefits, such as retiree health benefit obligations and deferred compensation plans. Furthermore, they can now do so with the knowledge that Congress has explicitly evaluated and acknowledged the value of such insurance.
