Common
Uses of Business Owner Life Insurance
Life
insurance has long been a valuable tool that business owners
use to reduce risk and to provide the basic financial foundation
for continued success. Most business owners recognize the importance
of life insurance and use it to solve many of the problems
associated with maintaining and growing a successful company.
Some common uses of business owner life insurance include:
key man insurance, security for loans, buy-sell agreement funding,
asset accumulation and estate planning.
Key Man Insurance
for Business Owners
With many small businesses the key man or key employee in
the business is the business owner. In these cases, key man
life insurance can be purchased on the life of the business
owner to protect the company in the event that he/she unexpectedly
passes away. With key man insurance, the business owns the
insurance policy and pays the premiums and is also the beneficiary.
If the business owner dies, the business receives the policy
proceeds and can use the funds to hire a capable replacement,
pay off debts or simply use the funds to buy time until the
businesses assets can be liquidated and the business can
be closed. In any event, key man life insurance on the business
owner can provide much needed stability if there is a sudden
and unforeseen death.
Life
Insurance as Loan Collateral
Loans are crucial to the expansion and growth of small businesses.
Whether your business is acquiring funds from a local bank,
the SBA or a private lender, many of these institutions will
require life insurance on the business owner(s) as security
for the loan. In most cases, inexpensive term life insurance
policies that offer guaranteed level rates for the duration
of the loan can be purchased to satisfy this requirement.
When buying life insurance to secure a loan, the company
pays the premiums, owns the policy and is the named beneficiary.
As soon as the key man policy is effective, a collateral
assignment agreement can be signed by the business owner
and the bank. The collateral assignment is a lien against
the policy proceeds. In the event of the business owner’s
death, the bank would have first rights to the policy proceeds
in the amount of any outstanding loan balance due. The business
would then receive any remaining proceeds. For an example
of a collateral assignment see, “Sample
Collateral Assignment.” Every bank or lending institution
as well as every insurance company has their own standard
collateral assignment form.
Buy-Sell
Agreement Funding and Life Insurance
A buy-sell agreement is a legally binding contract which
states that at an owner or partner’s death, disability,
retirement or otherwise separation from the company, the
individual’s interest in the company must be sold back
to the business or to the remaining owners at agreed upon
terms. These agreements are crucial for small and closely
held companies, as in many cases, the death or disability
of a business owner creates a significant financial burden
on the business as well as the remaining partners. To limit
this potential risk, most buy-sell agreements are funded
with life insurance and or disability insurance policies.
Depending on the type of buy-sell agreement, see “Types
of buy-sell agreements”, the business itself or
the individual partner(s) acquires a policy on each owner/partner
so that at death or disability the funds needed to “buy
out” the individual’s ownership interest are
readily available. For more information see, “What
is a Buy-Sell Agreement?”
Asset
Accumulation for the Small Business Owner
Successful business owners use life insurance as an essential
means to protect their businesses but they also use life
insurance as a vehicle to accumulate cash and future retirement
income. Life insurance policies offer a unique combination
of death benefits and tax advantages available in no other
financial product. These advantages include tax deferred
growth as well as the potential to access policy cash values
without paying taxes via withdrawals and policy loans. Additionally,
in most states, cash value inside a life insurance policy
is protected from creditors making it an especially effective
tool for business owners to use to grow their assets. For
more information on accumulating cash inside a life insurance
policy see, “Accumulating
Tax Free Retirement Income with Life Insurance.”
Smart business owners use nonqualified executive benefit
plans and other arrangements that use life insurance to provide
tax managed benefits for themselves and their partners. In
many cases, these individuals earn levels of income that
allows them to easily exceed the contributions limits under
a 401(k) plan or other qualified retirement plan. Properly
structured life insurance becomes a legitimate option to
grow wealth. There are many policy choices available including
traditional whole life insurance as well as variable and
equity indexed universal life policies. The type of life
insurance policy to use depends on the desired objectives
of the business or business owner.
Estate
Planning for Business Owners
In many cases, the majority of a business owner’s
estate is tied up in the value of the business. Without an
effective estate plan, including a business succession plan,
the business may have to close or be liquidated to pay estate
taxes. With the proper use of life insurance, a business
owner can provide the liquidity needed to pay any estate
taxes due at his or her death. For example, an irrevocable
life insurance trust (ILIT) can be established for the purposes
of owning a life insurance policy on the life of the business
owner (or business owners if married). The trustee of the
trust is usually the intended beneficiary. At the owner’s
death, the policy proceeds are payable to the trust which
can then, at the direction of the trustee, be used to pay
any applicable estate taxes.¹
¹ The above example is
for illustrative purposes only. Under no circumstances is
MEG Financial intending to provide tax advice. Please consult
your CPA or tax advisor for specific tax strategies that
might fit your circumstances.
For additional information on life insurance
for business owners, please call MEG Financial today at (877)
583-3955. One of our licensed insurance professionals
will assist you with any questions and provide a custom quote.
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