When you hear the term “life insurance” you may immediately think of a personal policy used to protect and provide for your family in the event of your death. But these days, many business owners are also relying on life insurance products to help protect the business itself when key people pass away.
Businesses are Going Beyond Personal Life Insurance
If you have ever considered getting life insurance in your business you may have come to the realization pretty quickly that the market for business life insurance is complicated. Many life insurance products sport a confusing set of terms, conditions, and fee structures, and these products fall under several different categories and sub-categories- each with their own unique spin.
For example, policies can be used by businesses to not only to keep important business operations going in the event of the death of an owner, partner, or key employee, but they can also have an assortment of other specific uses:
- They can be used to buy out a partner’s share of the business from the family members of the deceased.
- They can help a business cover the financial loss that results after a key employee dies or decides to leave.
- Some policies can become a valuable company asset that can be borrowed against
- Some policies can be used to compensate valuable employees by providing funds that can be accessed to help finance their retirement.
One of the biggest problems small business owners face when it comes to life insurance is that they have a hard time making sense of it all, and they may fail to appreciate the kinds of situations where having an adequate life insurance policy is a must. This can lead to costly mistakes down the road.
What Kinds of Life Insurance Coverage Exist for Businesses?
The following is a more detailed rundown of the common uses for business life insurance mentioned above. As a small business owner, you owe it to yourself, your family, and any stakeholders in the business to consider if any of these uses should apply to your business, and then to get in touch with the people who can help you make an informed decision.
1. Providing for surviving family members.
There are several life insurance policies that provide financial benefits for a business owner’s family. Family risk insurance is a personal policy that replaces the cash flow of the business in the event of death. There are also policies that help to prevent a future “distressed sale” of the business. Many small business owners take personal loans to help fund their businesses. When the business owner dies, the surviving family members may need to sell the business in order to cover the outstanding loan obligations. If these obligations are significant, the family may be tempted to sell the business for significantly less than its actual value. To prevent this, a business owner can take out a policy for an amount equal to any outstanding loan obligations.
2. Helping to fund business continuation.
“Key person insurance” ensures that a business will continue to have a cash flow if a critical leader or revenue-producing employee were to die. There are many indirect and even hidden costs that come with the loss of a critical business member. The business may lose clients, contacts or connections that bring revenue. There is also the cost to search, hire, and train a replacement. All of these expenses can add up very quickly, and without the proper life insurance to provide needed cash, the time between an employee’s loss and his or her replacement can deal a detrimental blow to a small business. In this case, the policy should be owned by the business, and there should be a policy for each key person involved.
3. Helping to buy and sell business ownership.
In conjunction with a well thought-out shareholder or partnership agreement, business owners can take out a buy-sell insurance policy. The pay out from the policy can then be used to buy back shares of the business at a pre-set price from surviving family members or heirs of a deceased owner, partner, or shareholder. This form of life insurance helps prevent the deceased business owner’s heirs from taking ownership of the business. Without it, the fate of the business could depend on heirs who may not have the desire nor skills to operate.
4. Supplemental retirement savings.
In some situations, permanent life insurance policies can be used as a retirement vehicle once you’ve met the maximum contribution amount of your qualified retirement plans. If you have a permanent life insurance policy (as opposed to a term policy), the funds you invest can become a valuable retirement asset.
Using a life insurance policy to supplement other retirement accounts has several advantages. First, cash is available to you tax-free, you can easily borrow against an account (especially where your beneficiaries are already financially independent) Plus, life insurance provides a tax-free insurance benefit to beneficiaries should the policyholder pass away. These plans are not for everyone, though, and they are by nature very complicated. So, you must get the help of a qualified adviser before signing on. For more details and ideas, see this article.
5. Estate tax funding.
If your business has been successful and it is worth a lot of money, then you may want to consider getting wealth transfer insurance. This a privately-owned policy set up to protect heirs in the event a business owner dies and the surviving family members must pay estate taxes.
Deciding Which Life Insurance Policy to Get and How Much to Pay
An I mentioned above, life insurance is a complicated product that can provide a variety of services for owners and their beneficiaries. With this in mind, one of the first steps in taking out a policy is deciding whether you will purchase the insurance yourself or use the advice and assistance of a life insurance professional. If you decide to purchase the insurance yourself, you can do so through a variety of Internet providers. Even if you chose to buy your own policy, you should nevertheless consult with either an attorney or accountant about business ownership structures and what type of insurance to purchase.
Regardless of how you go about making your purchase, you should be prepared to answer a few questions, such as:
- How your business is or will be structured (i.e. a Sole Proprietorship, Partnership, Limited Liability Company, or a Corporation)?
- Who are your key employees?
- Do you have the means and the systems in place to keep the business functioning should one of your key employees pass away?
- What would it cost you to replace any of those key people?
- If you were to die, what is the chance that your business will survive, and how may it affect your family.
In deciding what type of life insurance to purchase, cost may also be a factor. If you are just starting up a business or money is very tight, then term life insurance will be the way to go. On the other hand, if your business has been successful, then there are situations where you may want to consider a permanent policy. The major difference is that a permanent policy accumulates money over time and has an investment component to it. A company-owned permanent policy is a business asset that can be used to get financing or subsidize a retirement payout as mentioned above.
Resources to Learn About Life Insurance
In closing, here are a few online resources to check out for more information on life insurance policies:
- Life Foundation– A non-profit organization offering educational information on various insurance policies and products
- Insurance Information Institute– A site dedicated to improving the public understanding of insurance
- California Department of Insurance- A helpful guide on insurance policies and on finding the right insurer
- Insurance articles on About.com