In this article, we’re going to discuss life insurance strategies for business owners. Not only do life insurance products provide financial security for family and friends, but they can also help you achieve strategic goals for your business.
As a business owner, you can use your life insurance to insure key employees, finance buy-sell contracts and provide liquidity to pay off debts.
Life Insurance for Business Owners: What You Need to Know
Life insurance is often thought of as a risk-management tool that benefits named individuals if the policyholder dies. However, there are many ways that life insurance can benefit you — especially as a business owner.
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High-level: Life insurance can improve your business’s continuity and resilience.
Long-term: Life insurance can help you achieve your mid-to-long-term financial goals, like paying off your debt and balancing your estate distributions.
Understanding and exploring these ideas before you purchase a life insurance policy can help you be intentional about incorporating your life insurance strategy into your overall business plan.
Insuring Key Employees
One of the most common ways business owners use life insurance is by insuring key employees. It’s a simple yet effective way to strengthen your company’s financial position in the event of a key employee passing away.
While a life insurance death benefit payout may not cover the full costs of a loss of a key employee, it can help alleviate some of the financial pain.
Equalizing Estate Distributions
When dealing with a family business that is closely held, life insurance can help ensure that your heirs receive an equitable inheritance. There are many different ways to do this, but let’s take a quick example.
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Suppose you have a successful business and you have three children; one of them works for the family business and the other two don’t.
When you pass away, you want each of your children to receive approximately the same estate distribution.
So, you structure your life policy so that the employed child gets shares in the business while the other two get a cash death benefit.
Funding Buy-Sell Agreements
Life insurance is an essential part of a succession plan for many closely held companies. It allows a company to finance a pre-negotiated buyout transaction in the event of a business owner’s death.
For example, let’s say a privately held company has 9 equal-share owners:
A term life policy is bought on the life of every partner based on the present value of each partner’s share of the company.
The other eight owners are named as beneficiaries.
When one of the owners passes away, the company gets the death benefit.
The death benefit is used to buy out the remaining owners’ position and keep the company going with the new consolidated ownership structure.
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However, if the company continues to grow and appreciate in value, term life insurance may not be sufficient. To address this eventuality, permanent life policies may be purchased to provide an additional death benefit in a flexible manner.
An alternative to an entity purchase agreement is an insurance policy owned by the subject company on the lives of all the owners.
This approach is most helpful when a company has several different owners.
Paying Off Debts
One of the most common reasons a business owner buys life insurance is to have cash on hand to pay off debts when he or she passes away.
Common liabilities of focus include commercial real estate mortgages, MOUs, and estate taxes.
At the end of the day, the aim is to use life insurance so that heirs don’t have to deal with the burden of legacy or death-related debts.
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How much life insurance do business owners need?
How much life insurance your company needs depends on the purpose of the coverage. While this can vary greatly from company to company, the following general considerations apply.
How To Determine Amount of Coverage
- If you’re focusing on key employees, think about how much your company would have to spend to replace them.
- If your goal is to pay off your debts, think about how much you owe.
- If you’re looking to finance a buy-sell contract, the coverage should correspond to the company’s fair market value, which will increase over time (opt-in).
At the end of the day, business life insurance is about making sure your company (and your family) can get along without you.
Given how important this goal is, you don’t want to miss out on anything. You may want to talk to a good financial advisor to find out how life insurance can benefit your business.
Are there any downsides to having life insurance for business owners?
As with any investment, there are downsides to purchasing corporate life insurance.
The most obvious downside is that the premiums associated with life insurance policies and investment losses reduce a company’s capital, leading to a decrease in shareholder value.
Permanent life insurance policies, on the other hand, present a company with an excessive opportunity cost, as well as a lack of liquidity.
Generally speaking, well-capitalized firms are better off investing in established financial instruments, such as listed stocks and bonds.