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Bank Owned Life Insurance
(BOLI) was developed as a preferred method to informally fund non-qualified
benefit liabilities. The bank is is owner, beneficiary and payer of
Bank Owned Life Insurance on individuals for whom it has an “insurable
interest.” Unlike a qualified plan, where the company’s
contribution is tax-deductible, and there is no asset, a Non-qualified
plan’s contributions are not deductible, but the insurance policy
is an asset. When this asset exceeds the contribution the company
will book "other income” non-taxable on the income statement.
The BOLI cash value asset grows on a tax-deferred basis. In addition
if your company holds the BOLI policies until the death of the insured
individuals, it receives the death benefit proceeds income tax free.
(Please Note: Cash value increases and death benefit proceeds may
be subject to alternative minimum tax.)
Bank Owned Life Insurance (BOLI) is often referred to as “a
perpetual municipal with a yield that resets to the market.”
The benefit of BOLI is simple; it generates an increase of 150 to
200 basis points in after-tax investment yield depending on tax rates.
While increased yield is the result, investment cannot be the sole
purpose of the transaction. The OCC mandates that the purpose be incidental
to the business of banking. One such purpose is the financing of Non-qualified
supplemental executive or director benefit plans.
The BOLI transaction involves a reallocation of Tier I capital assets.
Assume a bank has an average Tier I capital earnings rate of 5.0%.
If the bank has a 40% marginal tax rate, this translates to a rate
of 3.0% on a net after-tax basis. The bank sells $1,000,000 worth
of Treasuries or Agencies and uses the proceeds to pay for a single
premium BOLI contract with cash value of $1,000,000 upon issue and
$1,050,000 at the end of the first plan year. The bank has earned
a 5.0% annual rate of return on its investment and books a non-taxable
net gain of $50,000. This compares to a gain of $30,000 that the bank
would have recognized had the assets remained in traditional taxable
investments. It is this $20,000 of tax-leveraged gain generated by
BOLI that finances or offsets the cost of new or existing plans.
Regulatory compliance is a foremost concern of most community banks
when considering a BOLI purchase. The OCC has issued technical bulletin
2000-23 that provides guidelines for banks to ensure that bank purchases
of life insurance are consistent with safe and sound banking practices.
The purpose for single premium BOLI is typically the financing of
existing executive fringe benefits and expenses.
Regulatory direction on purchase limits is relatively straightforward,
no more than 25% of capital and 15% or less with any one carrier.
OCC 2000-23 directs banks to also consider legal lending limits (12
CFR Part 32) and concentration of credit guidelines (OCC Bulletin
95-7, 2/9/95). A non-regulatory rule of thumb used by many bankers
and consultants is 1-2% of assets.
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