When you think about life insurance, your mind probably goes directly to protecting your family members, so they have the financial means to carry on after you die.
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Many business owners don’t realize they should also carry life insurance for their business—in addition to their personal life insurance.
Even if you are aware of the need, you likely have a busy schedule that keeps you from seeing it through, or you’re reluctant to take on the additional expense. But understand that while life insurance might be an expense on paper, it provides several benefits that far outweigh the cost of premiums, such as:
If a partner or key person in your business died tomorrow, what would you do? Business owners who don’t have business life insurance usually stumble over this question.
It’s certainly upsetting to think about one of your closest colleagues dying. However, it’s also upsetting to picture the grief being compounded by your business going under. Money aside, life insurance forces you to create a plan of action for a situation you are otherwise likely to avoid visualizing. And trust us, once you get into actually applying for life insurance, the discomfort lifts and you become focused on securing the coverage you need.
This is a given, but let’s talk about the different ways life insurance provides protection specifically for businesses.
Cross Purchase Agreement
A cross purchase plan is a type of buy-sell agreement in which each business owner or partner buys a life insurance policy on the other partners. Each policy’s face amount (the money that is paid out if the insured dies) is equal to the insured owner’s share of the net worth of the business.
Aside from protecting the business as a whole and each of the owners, avoiding taxes are another one of the benefits of this type of buy-sell agreement. With a cross-purchase agreement, the family of the deceased owner will receive an amount equal to their loved one’s fair market value of the business, tax-free, at the time of death.
Cross purchase agreements are ideal for businesses with two or sometimes three owners. More than three owners and the paperwork begins to pile up, because each owner must buy a policy on each of the other owners in order for the buy-sell agreement to be completed. For example, a company with five owners would require 20 life insurance policies:
- Owner 1 would need to buy a policy on owners 2, 3, 4, and 5.
- Owner 2 would need to buy a policy on owners 1, 3, 4, and 5.
- Owner 3 would need to buy a policy on owners 1, 2, 4, and 5.
- Owner 4 would need to buy a policy on owners 1, 2, 3, and 5.
- Owner 5 would need to buy a policy on owners 1, 2, 3, and 4.
Stock Redemption Plan
To avoid having to put together a large number of life insurance applications, businesses with three or more owners can create what’s called a stock redemption plan. In a stock redemption plan, partners or stockholders buy life insurance equal to the respective shares of the other stockholders.
If a stockholder dies, the death benefit is used by the surviving stockholders to “buy out” the shares belonging to the deceased person’s heir(s) at an agreed upon price. The deceased owner’s heir(s) receive immediate liquidity at fair market value for their business interest.
This prevents the business from having to sell off or liquidate assets to raise the money needed to pay off the deceased owner’s share of the business to their surviving family members. The deceased owner’s family also avoids paying taxes on the money that is left behind for them because life insurance settlements are typically paid as a tax-free lump sum.
Key Person Policy
Every company in every industry has its “key personnel” outside of the owners—from senior executives to top salespeople to tenured clerical workers. Key person life insurance provides a buffer for the business income loss caused by the sudden death of an employee with specialized skills.
For example, when a real estate agency loses a longtime associate broker, that person’s book of business will likely dissipate. Key person life insurance helps to negate the agency’s lost revenue that the broker was bringing in before they died.
How much life insurance is needed on a key employee? This is a difficult question with no “one-number-fits-all” answer. Most life insurance companies will approve up to 5-10 times a key employee’s annual salary, including bonuses. Some will go up to 15 times the annual salary. If the key employee is responsible for generating income for the business, life insurance companies will allow you to insure the business’s future profits. Most life insurance companies will approve up to 3 times the business’s annual gross profit or 5 times the business’s annual net profit.
As is the case with any life insurance policy, age and health are also factors. Insurance companies will also want to know the nature of the business, when the company was started, the net worth of the company, if the key person is an owner of the business, and if all key people will be insured.
If a key employee dies, the direct financial impacts are only the beginning of your challenges. Key person life insurance literally buys you time to interview potential replacements, onboard a new hire, and train them to fill the void. Finding a suitable replacement for a key employee can take some time, and getting them up to speed with the business can take even longer.
Without the influx of cash that life insurance provides, trying to replace an employee who has died unexpectedly can cause you to make a bad hire out of anxiety. Most businesses lose profit and customers when a key employee passes away. Key person life insurance can replace your business’s lost earnings for up to 5 years allowing your business to stay afloat while your executive’s take the time needed to hire the right candidate.
If you’re looking for funding to start or grow your business, life insurance is often a requirement to qualify for an SBA (U.S. Small Business Administration) loan. Life insurance policies purchased for SBA loans must be for the full amount of the SBA loan, with your lender named as primary beneficiary. This is essentially the SBA’s way of insuring their loans, so they don’t lose money when a borrower dies before they are able to pay off the loan. It also doubles as a form of protection for an entrepreneur’s loved ones so that their family does not have to shoulder their business debts if the entrepreneur dies.
Learn more about securing an SBA loan with life insurance here.
In addition to securing funding for a start-up business, the death benefits from a key person life insurance policy can also be used to pay down existing business debts or to fund future executive compensation plans, there are no restrictions on how the money can be utilized by the business. If your business needs funding to get started or grow, key person life insurance can also help you secure and attract investors.
Commercial lenders view key person policies as an asset improving the overall credit of a business. Some businesses are forced to shut down when a key employee passes away. Having life insurance in place provides potential investors with confidence because your business will have the funds needed to repay any outstanding loans in the event of an unexpected loss.
All of the above add up to priceless peace of mind knowing your business is prepared for a worst-case scenario. You’ve put in a lot of time and energy to build your business. Why leave your business or your business owner’s families vulnerable to the impacts of an unexpected death within the company?
When you contact an independent agency like JRC, you receive a higher level of attention than with big-box insurance companies, because we are not confined to one provider’s offerings or driven by daily sales quotes. We can shop 40+ top-rated life insurance carriers in just a few minutes to find you the best rates, all while applying our decades of combined experience to your specific needs. Call us toll-free at 855-247-9555 or request a free quote online to take the first step toward safeguarding the future of your business with life insurance.
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