Aside from the typical life insurance needs that most responsible people have, business owners may come across specific issues that can be best solved via purchasing a life insurance policy. While your average family should have protection in case of the loss of the breadwinner and caregivers, a business may also experience a financial loss were the owner or specific employees to pass.
While the actual loss would vary from that of a family, if a business does not protect itself, it can suffer extensive financial losses, or worse, need to shut its doors due to improper planning.
Here is a list of some types of life insurance for business owners, the situations they help in, and their benefits:
- Collateral assignment for a loan
- Executive benefits
- Funding a buy-sell agreement
- Group policies
- Key man insurance
- Retirement planning
Collateral assignment for a loan
One of the most common reasons life insurance brokers will often find themselves selling life insurance to small business owners is in order to secure a loan from the small business administration (SBA). The SBA usually requires a life insurance policy that is collaterally assigned to the bank providing the loan in order to secure against the untimely demise of the business owner.
Once the life insurance policy is issued and paid for, the collateral assignment is filed giving the bank first access to any amount outstanding on the loan. Collaterally assigning the policy is different from appointing the bank as a beneficiary on the policy and benefits both the bank and the policy owner in a few ways.
First and foremost, as the loan is repaid, there is no need to constantly update the beneficiary percentages. Rather, the only amount that would go to the bank at any time is the remaining unpaid balance of the loan.
Additionally, the owner of a life insurance policy can, at any time, change the beneficiary on the policy, without the beneficiary’s knowledge or consent, barring an instance of an irrevocable beneficiary. Were the bank to only be appointed as a beneficiary, the very next day, the policy owner could potentially completely cut the bank out of the policy by simply changing the beneficiary to a family member etc. By appointing the bank as a collateral assignee, the names, relationships or percentages of the beneficiaries are of no interest to the bank, as the beneficiaries only have rights to the remainder of the death benefit once the loan balance is paid to the bank.
Another benefit for the bank is that if the owner of the policy were to fall behind on their payments, the assignee would be notified, in contrast to a beneficiary where no such notifications are provided.
Executive Benefits
Business owners may purchase a whole life policy for themselves, or more often, their employees, as a benefit. The construction of the policy is flexible, however, a typical theme is that the premiums are paid by the business, and the cash values will vest in favor of the employee over a set number of years. This can incentivize the employee to stay with the company to reap the full benefits of the policy.
In case of the employee’s untimely demise, the death benefit will be paid to the employee’s family, with a possible refund of the premiums going to the business if that option was chosen on a universal life policy.
There are some tax implications for such policies as explained here.
Funding a Buy-Sell Agreement
A buy-sell agreement is a legal arrangement in which partners and multiple business owners agree that if one of the owners is no longer able to perform their function due to death or disability, they will sell their share to the remaining owners.
The logic behind such an agreement is to enable the business to continue without having new parties who may not have the businesses best interests in mind become shareholders in the company.
The actual agreement does not require funding, rather upon the need to exercise the contract, the business can come up with the required cash. The issue is, usually this will be a significant amount of money, and to achieve such liquidity, the business can suffer devastating losses in a fire-sale, or be required to take on high interest loans etc.
By funding a buy-sell agreement with a life insurance policy, the business partners are planning for a rainy day by covering this liability for a fraction of the cost.
Group Policies
Group life insurance for small and large businesses allows the owners and employees to take advantage of group rates and acceptance unavailable in the private market. While purchasing a policy yourself may turn out to be more economical if you are young and healthy, once age and health issues creep up, obtaining a policy via a group may be with your while. Group policies will often be issued through accelerated, guaranteed or simplified underwriting methods, thus making health issues not as big of a problem.
Key Man Insurance
Businesses, particularly small ones, often rely on a specific member of the team for their expertise, connections and general know-how. If this employee or owner were to pass, the business can suffer devastating losses. The need to find someone to replace and train this star would surely take time and cost a lot of money.
The key man life insurance policy concept was designed to fill this need. The insured is the special employee or owner, while the beneficiary is the business. When this unfortunate situation occurs, the business can rest assured that at the very least, financially, it will persevere.
Retirement Planning
Life insurance can be purchased and designed for its tax benefits and relied upon to supplement retirement. The policy can be within a qualified plan such as a 401k or unqualified. This is a strategy often used by business owners to set up a pension like fund for themselves while also having a death benefit in case the need arises.
FAQs
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Are life insurance premiums tax deductible for a business?
No, life insurance is not a business expense whether the owner is self-employed or owns a small or large business. The only way to deduct life insurance premiums is by owning the policy within a qualified plan.
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Can a business be a beneficiary of a life insurance policy?
Yes, this is usually done when buying a key man life insurance policy.
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Can a business buy life insurance?
Yes, the insured, of course, needs to be a physical person, and the business must have their consent to purchase the policy. But this is a common business strategy as discussed at length in this article.
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Can a business partner buy life insurance on another partner?
Absolutely, one of the best ways to fund a buy-sell agreement is by business partners taking out policies on one another.
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Can a company pay for employee life insurance?
Definitely, this would usually be an executive benefit, as discussed above. Make sure to be wary of the tax ramifications.
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Can an LLC own a life insurance policy?
Business-owned life insurance policies are not limited to any specific type of corporation or structure of entity, and can be used by virtual or physical businesses.
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Can you use life insurance to start a business?
Cash values of permanent life insurance policies can be used for whatever you would like, including to start a business.
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Do small businesses offer life insurance?
Some do as part of their benefit packages on a case-by-case basis. If your company does not, or even if they do and you would like to supplement it, here at Sproutt.com, we would be glad to help you out.
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How can life insurance help business owners?
Life insurance can assist businesses by insuring against various situations where cash may be needed quickly, such as the death of a partner or employee.
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Should a business owner have life insurance?
A business owner, just like any other responsible adult, should have a life insurance policy for their family. Aside from that, business owners have special needs that can be filled with business-owned life insurance policies as discussed in this article.
