Bank Owned Life Insurance (BOLI) Overview
Bank Owned Life Insurance (BOLI) is a type of life insurance policy that is owned by a bank or other financial institution. It is designed to provide a death benefit to the policyholder’s beneficiaries, but it also has a cash value component that can be borrowed against or withdrawn. BOLI can be a useful tool for estate planning and business succession, but it is important to understand the benefits and drawbacks before purchasing a policy.
Benefits of BOLI
There are several benefits to owning a BOLI policy. First, the death benefit is paid out tax-free to the policyholder’s beneficiaries. Second, the cash value component of the policy grows tax-deferred, meaning that you do not have to pay taxes on the earnings until you withdraw them. Third, you can borrow against the cash value of the policy without having to pay taxes on the loan proceeds. Finally, BOLI policies can be used to fund estate taxes or to provide liquidity for a business.
Drawbacks of BOLI
There are also some drawbacks to owning a BOLI policy. First, the premiums are typically higher than for other types of life insurance policies. Second, the cash value component of the policy grows more slowly than the cash value component of a traditional life insurance policy. Third, if you borrow against the cash value of the policy, you will have to pay interest on the loan. Finally, BOLI policies can be complex and difficult to understand.
How BOLI Can Be Used in Estate Planning and Business Succession
BOLI can be a useful tool for estate planning and business succession. For example, a BOLI policy can be used to provide liquidity for an estate by paying off debts or taxes. It can also be used to provide a death benefit to the policyholder’s beneficiaries. In a business succession situation, a BOLI policy can be used to provide funding for a buy-sell agreement or to provide a death benefit to the surviving business owner.
BOLI Investment Strategies
Banks utilize various investment strategies for BOLI policies, aiming to optimize returns while managing risks. These strategies involve investing in a diversified portfolio of assets, including bonds, stocks, and alternative investments.
BOLI investments are typically structured as separate accounts, with each policyholder having a dedicated account. The bank manages these accounts based on the policyholder’s investment objectives and risk tolerance. The portfolio is regularly monitored and rebalanced to maintain the desired risk-return profile.
Risk and Returns
BOLI investments carry potential risks and returns. The primary risk is market risk, which arises from fluctuations in the value of the underlying investments. The return potential is influenced by the investment strategy and the performance of the underlying assets.
Banks typically employ a prudent investment approach to mitigate risks. They diversify the portfolio across different asset classes and sectors, reducing the impact of any single investment’s performance. Additionally, banks may use hedging strategies to further reduce volatility and protect against market downturns.
BOLI Policy Features and Options
Bank Owned Life Insurance (BOLI) policies offer a range of features and options to meet diverse financial planning needs. Understanding these features is crucial before purchasing a BOLI policy.
BOLI policies typically provide:
Death Benefits
Death benefits are the primary payout from a BOLI policy upon the insured’s death. Common types include:
- Face Amount: The fixed death benefit amount specified in the policy.
- Graded Death Benefit: Death benefit increases over time, usually with premiums.
- Return of Premium Death Benefit: Premiums paid are returned to beneficiaries in addition to the death benefit.
Cash Value Accumulation
BOLI policies often accumulate cash value, which grows tax-deferred. This value can be borrowed against or withdrawn (with potential tax implications).
Riders
Riders are optional add-ons that provide additional coverage or benefits, such as:
- Waiver of Premium Rider: Premiums are waived in case of disability.
- Accidental Death Benefit Rider: Provides additional death benefit if death is accidental.
- Long-Term Care Rider: Covers long-term care expenses.
It’s essential to carefully review the policy terms and conditions to fully understand the features and options available and to ensure they align with your financial goals.
BOLI Tax Considerations
BOLI policies have unique tax implications that policyholders and beneficiaries should be aware of. Understanding these tax considerations is crucial for making informed decisions regarding BOLI investments.
Tax Treatment of Death Benefits
Death benefits from BOLI policies are generally received tax-free by the beneficiaries. This tax-free treatment makes BOLI an attractive estate planning tool, as it allows individuals to pass on wealth to their heirs without incurring estate taxes.
Tax Treatment of Cash Value Withdrawals
Cash value withdrawals from BOLI policies are treated as loans and are not subject to income tax. However, if the policyholder withdraws more than the basis (the amount of premiums paid into the policy), the excess is taxed as ordinary income.
Tax Treatment of Policy Loans
Policy loans are not taxable when taken out. However, the interest paid on the loan is not deductible for income tax purposes. Additionally, if the policyholder fails to repay the loan, the loan amount may be treated as a taxable distribution, which could trigger income tax and surrender charges.
Potential Estate Tax Consequences
BOLI policies can have estate tax consequences if the policyholder retains ownership and control of the policy until their death. In such cases, the death benefit may be included in the policyholder’s taxable estate, potentially increasing the estate tax liability. To avoid this, policyholders can transfer ownership of the policy to an irrevocable trust or name a beneficiary other than their estate.
BOLI Suitability and Due Diligence
Evaluating the suitability of a BOLI policy requires careful consideration of several factors. These include the individual’s or business’s financial goals, risk tolerance, and tax situation. Additionally, it’s crucial to conduct thorough due diligence before purchasing a BOLI policy.
Factors to Consider
- Financial Goals: BOLI can serve various financial goals, such as funding retirement, providing life insurance coverage, or supplementing an estate plan.
- Risk Tolerance: BOLI investments carry varying degrees of risk. Individuals or businesses should assess their tolerance for potential losses before investing.
- Tax Situation: BOLI policies have unique tax implications that should be carefully considered.
Due Diligence Process
Before purchasing a BOLI policy, it’s essential to follow a thorough due diligence process:
- Research Insurance Carriers: Compare the financial strength and reputation of different insurance carriers offering BOLI policies.
- Review Policy Terms: Carefully examine the policy terms, including premium payments, death benefits, and surrender options.
- Consult a Financial Advisor: Engage with a qualified financial advisor to assess the suitability of BOLI and guide you through the decision-making process.
Selecting a Reputable Insurance Carrier and Financial Advisor
Choosing a reputable insurance carrier and financial advisor is crucial for successful BOLI planning. Consider the following:
- Insurance Carrier: Look for carriers with a strong track record, financial stability, and experience in BOLI.
- Financial Advisor: Select an advisor with expertise in BOLI, understands your financial goals, and provides personalized advice.
