The BOLI Challenge
Evaluate how to free up capital, obtain liquidity, and potentially earn higher rates of return.
Through acquisitions, a reduction in bank-owned life insurance (BOLI) portfolio yields, and a changing population of employees, banks can be challenged with managing legacy BOLI portfolios. Some banks have all or a portion of a its BOLI holdings performing well below acceptable net returns.
Banks are often caught in what we call the “BOLI Tax Trap” – this is where all or a portion of the BOLI portfolio is delivering low net returns, but the age of the portfolio creates two significant problems:
Potentially large embedded taxable gain
The age of the portfolio may create a charge to earnings problem due to the embedded tax gain if the bank were to surrender part or all of the portfolio.
Insureds are no longer employed
Potential tax-free exchange options to a new BOLI product may have limitations.
Are your legacy BOLI net returns below market yields?
Does your BOLI asset have taxable gains upon surrender?
Is there a large tax cost and/or negative earnings impact to obtain immediate liquidity?
Do you have MEC tax penalties associated with a surrender?
If the life insurance policy is or will become a Modified Endowment Contract (MEC), be aware that the following considerations apply:
Unlike non‐MECs, which allow policy owners to first recover their non‐taxable “investment in the contract” (i.e., policy basis) when making policy withdrawals, MECs follow a “last in, first out” (“LIFO”) rule, which requires policy owners to first withdraw taxable income from the MEC.
If the MEC has income accumulation, income taxation will be triggered on withdrawals, policy loans, pledges of the MEC as loan collateral, cash dividends, and dividends retained and applied by the insurance company to policy loans.
An additional 10% tax also applies to the taxable portion of a MEC distribution, unless the distribution: (1) is made after the policy owner attains age 59½ or becomes disabled or (2) is part of a series of substantially equal periodic payments that are made at least annually for the life expectancy or joint life expectancies of the policy owner and his or her beneficiary (the “added 10% tax”).