Life insurance is purchased primarily as a means to keep your immediate family safe in the event of your death. However, as a business owner, you take on a whole new group of dependents outside of your family. Employees, stakeholders, and operations can be subject to serious upheaval if you pass away.
When your business is part of your lasting legacy, you want to ensure its survival. Investing in business life insurance is so crucial for many because it sustains businesses through transitions and heavy expenses. This article will explore business life insurance benefits and different options to consider in setting up the best policy.
Why Do Business Owners Need Life Insurance?
Good business owners carry a lot of value that is hard to replace if they pass unexpectedly. Family members could be negatively impacted because they might not be capable of taking over the business, forcing them to possibly sell. If selling is difficult, they may have to move it at a steep discount.
Your family may also be at risk of losing more than just money. If you have business loans backed by collateral, such as your home, your death could initiate the loss of important assets. Having a personal life insurance policy is critical to protect your family.
Family members are not the only ones relying on you for their livelihood. Your employees, co-owners, and your customers have a lot at stake. When they are left with a giant hole in the organization, operations and revenue generation suffer.
When you die, an efficient transfer of ownership keeps operations running fluidly and maintains the hierarchy of the organization. Without business life insurance, you could see a combative disagreement between owners when it comes time to reallocate your shares.
Business and Tax Advantages
Business owners also enjoy tax benefits and increased wealth when they have whole life insurance plans. Contractors and other self-employed individuals pay more in taxes but can offset expenses from life insurance perks. For instance, business owners can grow retirement income and the plan’s cash value tax-free, as well as take out loans against the policy.
Taking out a policy loan can help cover business costs when they arise. This avoids the need for high-interest loans from banks and the interest earned by the policy accumulates as normal even if large loans are taken out.
Business Life Insurance Options
Like personal life insurance for your family, life insurance for your business is available in either term or whole life policies. There are two critical concepts in life insurance at the business level — key person insurance and buy-sell agreements.
Key person insurance is company-owned and used to pay out the death benefit to the beneficiary (the business) if a “key person”, such as the CEO, passes away. A key person could be an owner, an employee with specialized skills, or an employee who maintains critical customer relationships.
The business pays monthly premiums for policies on key persons to pay out a certain amount when they die. This is crucial to lessen the effects of the short-term losses that will result from a slowdown in operations and resources being applied to the replacement effort.
When multiple partners own a business, a buy/sell agreement assures a smooth transfer of ownership when one dies. In these agreements, co-owners sign a contract detailing how, if one dies, the surviving owners will purchase their share. There are several benefits to adding a buy-sell agreement to a business life insurance plan:
- Stops ownership from transferring to a surviving spouse or other heir who is either unwilling or incapable of operating the business.
- Provides money to the surviving spouse or estate to account for the lost income.
- Keeps the business from requiring a “buy out” of the deceased’s shares through selling the business.
- Uninterrupted operations and consistency in ownership and vision.
There are some key components to consider when setting up a buy-sell agreement:
This allows business partners to buy life insurance on one another. They set the coverage amount (the value of their co-owners stake) and pay the accompanying premium. If the covered owner dies, the death benefit pays out to buy their shares.
Cross-purchase agreements get complex and more expensive per person, with more owners. If there are two owners, there are two agreements. Three owners, however, would entail six policies, four owners have 12 policies, and so on.
In this scenario, the business, rather than the individuals, purchases a life insurance policy on the owners. If an owner dies, the death benefit pays out to the business. There are, however, certain circumstances, such as a disability, retirement, or bankruptcy, that can allow a living owner to trigger a transfer of ownership in these agreements.
Entity-purchase plans, also known as stock redemption agreements, are common in corporations with a large number of shareholders. Rather than having multiple policies per owner, as in a cross-purchase agreement, there is only one policy per owner that is covered by the business.
Trusteed cross-purchase agreement:
Like entity-purchase plans, a cross-purchase agreement is helpful for multiple co-owners. Life insurance policies are managed by a third-party trustee. When an owner dies, the trustee pays out the funds to the estate for the deceased owner’s shares, which are then split among the surviving owners.
Life Insurance to Attract Quality Employees
Life insurance can also be leveraged to improve your business. You can offer different life insurance plans as incentives to attract and retain quality employees.
Key employee coverage:
Key employee coverage is not just for owners. If you want to attract the best in the business for key roles throughout the company, you can offer them fully paid insurance. Your business can assign the employee’s estate as the beneficiary and enjoy tax benefits for paying their premiums.
A life insurance plan including vesting is a great financial perk for employees. The employee owns and is covered by a whole life insurance policy. The policy’s value grows as long as the employee stays with the company.
The employee controls the contributions, death benefit payout and investments for their policy. As the value grows, they can take out loans against the policy and sometimes even withdraw funds. This is a powerful incentive for a key employee that offers retirement benefits and security.
Group life insurance:
Rather than focusing on filling one role with quality, a group life insurance setup benefits employees throughout the entire organization. Group policies usually work on five-year terms, which are renewed as employees stay with the company.
Death benefits can be either a fixed, flat-dollar amount or a salary-multiple amount, in which an employee’s coverage equals their annual salary times a multiplier. For instance, an employee with a $100,000 salary could have a multiplier of two, so their coverage would be $200,000.
A common approach is to make the coverage equal to one year’s salary for the employee. However, by adding voluntary group life, workers can pay in from their paychecks to buy additional discounted coverage.
A group life insurance offering makes your benefits package competitive. You can also choose different policies depending on how employees are classified. For example, you can set up a flat-dollar amount (e.g. $10,000) for warehouse workers and a salary-multiple package for high-level employees.
How to Buy Business Life Insurance
Buying business life insurance follows many of the same steps as individual life insurance:
- Determine who needs to have policies and their coverage amounts.
- Shop for policies and get quotes.
- Decide on an insurer and submit your application.
- Take a medical exam. Note: With group life policies, the employee does not need to prove their health to qualify for coverage.
- Wait on underwriting approval and sign.
When using life insurance to fund a buy/sell agreement, choosing between term and whole life insurance depends on how long you plan to own the business. If you plan to sell in a short period (e.g. within 15 years), a term plan would be appropriate. If you intend to stay with the company for the foreseeable future, a permanent policy would be sensible.
When covering key employees, account for how much revenue could potentially be lost if they die. Estimate how much time and money it would cost to recruit and train their replacement. Buy enough insurance, either term or permanent, to cover those costs.
Working with multiple policies and trying to balance individual plans with business plans gets complicated quickly. It is critical to compare policies and work with a knowledgeable insurance broker to get you an appropriate, high-value plan. There are numerous opportunities to expand coverage, reduce costs and even increase your wealth with smart investments in business life insurance.
Business life insurance guarantees the well-being of the people and entities that have been meaningful to your life and your success. If you want to protect those close to you and ensure your legacy for the next generation, NextGen Life Insurance is here to get you the best coverage and rates for your needs. Get your free quote today or call us at 646-216-4199