Life insurance for business owners
The list of people who depend on you grows as you start a business: family members, business partners, and employees.
Life insurance gives them a financial safety net in the event of death, taking some of the worry out so you can focus on day-to-day problems. Consider coverage when developing business plans.
“This is an essential conversation to have and a topic to be covered,” says Michael Weisman, financial planner and president of the Wealth Products Group for Enterprise Trust in St. Louis.
The type and amount of life insurance you obtain will depend on your goals for the policy. Life insurance can meet various needs for a business. Here are some of the reasons to buy:
Take care of your family
You need life insurance if someone is dependent on your income. In the event of death, your family could use the life insurance proceeds for household expenses, college education, and whatever else they needed.
Term life insurance, which covers a number of years, is sufficient for most people.
Choose a term that is long enough to cover the years when people will be dependent on you financially. Most parents buy a term to last until the kids have graduated from college.
Pay off personal and professional debts
Life insurance is essential if you are using a home or other personal property as security for a business loan. Imagine a grieving spouse struggling to pay off debt to avoid losing the home.
Winding up the business to pay lenders is not always an option. The business might not be worth much without the owner at the helm. Or the heirs might have to offload it at a discount when forced to sell the business quickly.
A lender may require the borrower to purchase life insurance as a condition of the loan. But don’t name the bank as the beneficiary of the life insurance, says Weisman. Instead, ask the life insurance company for an “assignment of collateral” after the loan is approved. Under an assignment as collateral, the insurer will use the life insurance proceeds to pay off the loan and return the remainder to the beneficiary of the policy, such as a spouse.
Choose term life insurance that matches the length and amount of the loan.
You can buy a single term life insurance policy to replace income and cover debts or multiple term life insurance policies, such as a 30 year policy to replace income and a 15 year policy to cover a 15-year loan.
Help heirs pay inheritance tax
Even if you’re strapped for cash, your business assets could push you over the federal inheritance tax limit, which is $ 5.49 million for a single person or $ 10.98 million for a couple married in 2017. Your state property tax threshold could be lower. An impending tax bill could force your heirs to hastily sell the business.
Nathan Mahlik, an insurance agent for State Farm in Danville, Calif., Says he saw this scenario play out in farming communities in the Midwest, where he previously lived. When a family had to sell land to pay property taxes, others in the area knew they were desperate to sell and made modest offers.
Life insurance proceeds can help heirs pay inheritance tax. They can keep the business intact or take their time selling it for a decent price.
For estate planning, choose permanent life insurance, such as whole or universal life insurance, which provides cover for life. A term life insurance policy is not appropriate because it could expire before your death.
A permanent life insurance option called a “second death” policy may be a good choice for couples, Mahlik says. This type of insurance pays when the second person on the policy dies. The policy works because husbands and wives do not owe estate taxes on property inherited from each other. Inheritance tax becomes an issue for future heirs, such as a couple’s adult children.
Equalize inheritances for adult children
Life insurance helps business owners treat their adult children fairly when they are not all part of a business. A parent, for example, is considering leaving the business to their daughter and wishes to give an equal inheritance to a son. A life insurance policy can help do this.
Choose a permanent life insurance policy, such as whole life or universal.
Purchase sufficient coverage to fairly compensate children who do not inherit the business.
Help finance a buy-sell agreement
A purchase-sale agreement is a legally binding contract between the co-owners of a business. The agreement specifies what happens to the property rights of a business partner who dies, becomes invalid or leaves the company. Life insurance for business owners is a simple way to provide money for a buyout if one of the partners dies.
Here’s how it works: Owners or business purchase policies insuring each partner. In the event of death, the life insurance proceeds are used to redeem that person’s share of the business. A funded buy-sell agreement helps avoid disputes and turmoil. Imagine if your partner died tomorrow. Without a buy-out agreement and no way to fund it, you could end up in business with your partner’s spouse or children.
Choose the lifetime if you plan to sell the business in a relatively short period of time, say 10 years.
Consider permanent life insurance if you plan to be in the business for the long term, say 20 years or more.
Short on cash but want permanent coverage? Buy a term life insurance policy that can be converted to permanent life insurance later.
Cover losses due to the death of a key employee
Imagine if an employee who is difficult to replace suddenly dies. No matter how hard everyone worked to get things done, the company would likely lose revenue as the team scrambled to regroup.
Life insurance can provide “working capital to help them,” Weisman explains.
For example, Mahlik worked with a small construction company that purchased life insurance for their crane operator. If the crane operator dies, the company can use the life insurance money to make up for lost income while they recruit and train a replacement for this difficult position.
Estimate the loss of income due to the loss of the employee and the cost of finding and training a replacement.
Buy enough term life insurance to cover costs and replace income.
Help retain talent
Permanent life insurance can provide additional compensation to key employees, encouraging them to stay.
Typically, a business will purchase permanent life insurance for the employee. Although the company pays the premiums, the employee owns the policy and can then use the cash value to supplement their retirement income.
In a “dollar split” life insurance policy, the company and employee share the costs, death benefit and cash value of the policy.
Work with an experienced life insurance agent to advise business owners on compensation strategies.
Consult with a lawyer or tax advisor to set up the arrangement.
How life insurance helps owners and types of businesses buy
Protect your family by replacing your income
Covers personal and professional debts
Provides money to heirs to pay inheritance tax
Equalize an inheritance if all the kids don’t get the business
Finance a buy-sell agreement
Provides working capital in the event of the death of a key employee
Provides a benefit for valuable employees
Life insurance for business owners meets a variety of needs. Talk to a financial advisor who has experience helping businesses like yours.