Life Insurance for Business Owners

Income Replacement

As a business owner, you’re likely the primary breadwinner in your household.
If you should die, there will need to be a sufficient amount of life insurance so your surviving loved ones can continue financially.

This is called income replacement because your death benefit can help your loved ones
continue with normal living expenses, handle college funding, continue with investing for retirement, and leave a paid-for home.

If you purchase cash-value life insurance like Universal Life or Whole Life, over time your policy’s cash value can become an effective source of cash because of the tax-deferred interest that is credited to your cash account. Over time the compounding interest earned by your life insurance policy can be accessed via policy loans and used for any reason.

Yes, you will pay some interest on the loans but the interest is sufficiently offset by the continued interest your account will earn because, even though you collateralize your cash account, the account continues to earn interest.

Additional Protection for Key Executives

In almost any business, there are one or more Key Executives whose income is higher than other employees and, as such, they’ll likely require more life insurance coverage than most employer-sponsored plans will offer.

Their income sets them apart from support employees and staff members who are generally comfortable with having a life insurance death benefit that is one or two times their annual salary.

According to Entrepreneur.com, Key Person Insurance is defined as:

“Life insurance on a key employee, partner or proprietor on whom the continued successful operation of a business depends. The business is the beneficiary under the policy.”

Service businesses are especially vulnerable to an impact on their bottom line when a key executive dies unexpectedly or becomes disabled.

The manner in which most service businesses operate makes them perfect candidates for key-person insurance. Most service businesses rely on a small number of key individuals to bring in a majority of the revenue that supports the business operation. These key people might be executives or partners in the company or team members who have proven to be considered valuable to ensure company operations continue quarter after quarter and year after year.

By offering key executives additional coverage, these key executives will not have to purchase individual policies with a death benefit that is sufficient to cover the lost income to their families if they should die.

This key executive life insurance offer not only separates your company from your competition, but it will also make it difficult for other companies to poach your key personnel unless they can offer more benefits than you are offering.

Provide Executive Bonus

Not only can a company separate itself from the competition by offering high death benefit life insurance for key executives, but the company can also help pay for that additional death benefit via an executive bonus plan.

The bonus plan should be sufficient to cover not only the cost of the life insurance but also any tax liability that will likely result from the additional benefit of the life insurance plan for the executive.

Additionally, the key executive can access the cash value in the life insurance policy to supplement his or her retirement plan or access the money for any other reason. Moreover, if the executive dies while employed with the company, his or her beneficiary would receive the death benefit tax-free.

Succession Planning

Most business owners are concerned about business continuation, especially if they have partners or stakeholders who are financially invested in the company. Generally, the business owner’s counsel, accountant, or insurance agent will recommend having a buy-sell agreement in place that spells out how the business will continue after the death of an owner.

Generally, when a business partner passes away, that partner’s share of the company passes on to the deceased partner’s heirs. The problem that inevitably pops up is that the heirs who now own shares in the company are not interested in joining the organization or the remaining partners are not interested in having the heir or heirs join the organization.

For example, ABC Realty Group is a partnership organization with three partners owning the same value of shares. If one partner dies unexpectedly, his or her shares in the business would pass on to surviving family members. Certainly, the surviving partners will want to purchase those shares and return them to the partnership, but the partners may not be prepared to offer the value of the shares to the recipient.

In this case, the business needs a Buy-Sell Agreement (also referred to as a buyout agreement) to protect the owners or partners of a business if one or more of them should die unexpectedly. The Buy-Sell agreement, which is normally drawn up by an attorney or CPA, provides specific instructions for the surviving business owners if one of the owners should die.

In the case of  Buy-Sell agreements, term life insurance can be the most affordable funding solution for your business continuation plan. Term policies can be issued with up to 30-year terms and can also be purchased with various riders that serve to broaden the coverage in the policy. Fortunately for business owners, term insurance has become very competitive and policies can be issued with very high death benefits, but with very affordable rates.

With a buy-sell agreement in place that is funded with life insurance, the death proceeds from the life insurance can be used by the surviving partners to buy back the shares of the company from the heir or heirs without the surviving partners having to come out-of-pocket or liquidate company assets to buy the shares.

Finally, if there is a concern about tax liability, consider the following:

• All insurance premiums used to finance a buy-sell agreement are not tax deductible.
• The death benefit is delivered tax-free irrespective of who acquired and owns the insurance policy unless the death benefit is payable to certain corporations. The death benefit that is received by the C corp may result in an alternative minimum tax for the corporation. For the death benefit to be received tax-free, there can be no exchange for valuable consideration.
• Insurance premiums paid by a company in which the shareholder is the named insured are not regarded as taxable income to the insured person.
• There is no gift tax responsibility upon the execution of a buy-sell agreement.
• When implementing a cross-purchase agreement, one should be cautious of the transfer for value rule.

Estate Equalization

In almost every business owned by a family, some family members participate in day-to-day operations while others rarely get involved. When the head of the business attempts to split shares of the business based on participation in the day-to-day operations, this will likely cause conflicts within the family and affect the operation of the business.

Rather than planning to divide shares of the business based solely on “sweat equity,” the head of the family business can use a life insurance policy designed to provide the value of their shares in the company rather than the shares themselves, thus leaving the company intact for those family members that are actually involved in the company business.

Income

With a life insurance policy in place, a business owner, key executive, or stakeholder, can provide a stream of replacement income in the event of his or her death.

The death benefit for a policy to replace income should not be arbitrary or speculative but rather based on an “insurance needs analysis” that is based on the financial needs of the surviving family members. Most reputable and experienced insurance agents will suggest this and offer to conduct the analysis at no charge.

The insurance needs analysis will help the applicant establish a death benefit sufficient to fill the financial needs of the family and deal with the significant loss of income.

Typically the needs analysis will consider the long-term financial needs of the family that will provide for monthly living expenses, outstanding mortgage balance and personal debt, college expenses for children, retirement investment for a surviving spouse, and the costs of funeral and burial services.

The needs analysis will examine the financial expenses of the family minus any liquid assets which will determine the actual death benefit needed from the insurance policy.

Provides Money for Heirs to Pay Estate Taxes

Although many family businesses are exempt from federal estate taxes because the value of the business is less than the exemption limit of $11.7 million for a single person or $23.4 million for a married couple in 2021, most states have set an inheritance tax that could be levied on the business when passing the assets on to heirs.

Any family business should consider in advance whether or not they could be subject to any federal or state inheritance taxes and prepare in advance to provide the money to cover these taxes.

The best solution for the risk of inheritance taxes would be for the family business owners to provide a survivorship life insurance policy with a death benefit sufficient to cover the risk of having to pay these taxes when the property is transferred.

A survivorship or second to die life insurance policy would pay out only upon the death of the second insured with the funds designated to cover any tax liability resulting from the transfer of the business to the heirs.

Equalizes the Inheritance if not all Children Inherit the Business

A life insurance policy can be used to help a business owner fairly treat their adult children who may or may not be involved in the business. For instance, if you have three children but only two of them are involved in the business, a life insurance policy would guarantee that the third child would receive an inheritance equal to what the other two children received.

Funds a Buy-Sell Agreement

As was mentioned earlier in this article, any business owner who has partners, stakeholders, or employees, should consider having a buy-sell agreement and funding it with life insurance. The death benefit in the insurance policy could be used to transfer the business owner’s shares to:

• Surviving Partners
• Stakeholders
• Key Executives
• Employees

If the business owner should die unexpectedly, the beneficiary (the business) would have the funds needed to purchase the shares from the business owner’s heirs or any of the groups listed above.

Types of Life Insurance Policies for Business Owners

Whether your business is a large proprietorship, partnership, or small Mom and Pop operation, there are certain risks inherent to any business that should be mitigated using a specific type of life insurance:

• Key-person Insurance – When you have one or more employees that are responsible for the bulk of the company’s revenue or who exceed others in attracting new customers, a key-person insurance policy will ensure that the business will not have to suffer financially if any key-person dies unexpectedly.
• Buy-sell Agreements – A Buy-Sell Agreement is typically considered a key component for business continuation planning. This agreement defines what measures will be taken when a business owner dies and is funded with life insurance to pay for the measures that must be taken.
• Collateral Assignment Life Insurance – Collateral assignment life insurance is a life insurance policy that is purchased as a requirement to get a loan. Some lenders will ask or require the borrower to provide life insurance in the amount of the loan and name the lender as beneficiary.
• Executive Bonus Plan Life Insurance – Using a life insurance policy to fund an Executive Bonus Plan is a simple and straightforward method for rewarding key employees without all the headaches that are generally associated with employee benefit plans. Compared with other funding methods, life insurance is a much simpler solution since the insurance premiums are tax-deductible and there are virtually no administrative duties.

Term or Permanent Insurance?

In some business insurance situations, a permanent policy (whole or universal life) can provide some benefits that term life insurance cannot. First of all, a whole or universal life policy will provide cost recovery at some time, either upon the death of the insured or, in some cases by accessing the cash value of the policy. Additionally, if the business is the owner of the policy, the cash value will show up on the books as an asset.

Another benefit of permanent insurance is that a properly funded permanent policy can be used as a retirement supplement for the owner or the key employee (as a distribution if the employee leaves or retires). Businesses often offer this benefit as an incentive (golden handcuff), a great method of retaining employees. We advise that you check with your accountant to properly structure this type of arrangement.

If the premiums for a permanent policy don’t fit into the business budget, the return of premium term life insurance is another solution we recommend for business insurance. With this type of policy, the business would pay a level premium and, at the end of the term, the business would receive all the premiums back.

The premiums for these policies are more expensive than regular term policies, but there will be a full cost recovery if the insured person outlives the policy. Or, as with the cash value of a permanent policy, the premium refund can be used as a golden handcuff, providing the key employee with an incentive to stay employed.

What about Tax Considerations?

While tax concerns should be addressed by your CPA, there are some basic considerations that can be addressed here:

• All insurance premiums used to finance a buy-sell agreement are not tax-deductible.
• The death benefit is delivered tax-free irrespective of who acquired and owns the insurance policy unless the death benefit is payable to certain corporations. The death benefit that is received by the C Corp may result in an alternative minimum tax for the corporation. For the death benefit to be received tax-free, there can be no exchange for valuable consideration.
• Insurance premiums paid by a company in which the shareholder is the named insured are not regarded as taxable income to the insured person.
• There is no gift tax responsibility upon the execution of a buy-sell agreement.
• When implementing a cross-purchase agreement, one should be cautious of the transfer for value rule.

How to Buy Life Insurance as a Business Owner

Buying life insurance as a business owner is basically the same as buying for personal reasons, only the risk that you need to mitigate is different.

Certainly, any licensed agent can place your policy or policies with a company they represent, but you’ll have an advantage if you contact an experienced and reputable insurance broker who represents many of the highest-rated insurance companies.

An independent agent who has experience placing business-related cases will advocate for you rather than the insurance company. He or she will help you navigate the life insurance landscape and endeavor to steer you around the bumps in the road that are associated with the shopping, underwriting, and purchasing process.

You can contact the insurance professionals at LifeInsure.com at 866-868-0099 during normal business hours or contact us through our website 24/7.