In part one of “5 Ways Your Business Can Benefit from Life Insurance,” we named 3 Myths that business owners may have about life insurance. We also mentioned a study conducted by The Guardian Life Small Business Research Institute, which interviewed nearly 700 small business owners to determine their top ten business concerns.
As we summarized in part one, five of the top ten financial concerns can be impacted by life insurance solutions for business owners:
- Planning for the future
- Tax minimization
- Cash flow management
- Financing capital expenditures
- Providing employee benefits (which also helps with what these small business owners identified as their TOP challenge of finding the right employees).
In Part One we covered #1 – planning for the future through such solutions as buy-sell agreements and key employee policies and #2 – tax strategies. Today, we explore the last three challenges named above, and how life insurance can provide surprising solutions for business owners.
- Cash Flow Management.
Cash Infusion. The ability to borrow against cash value in lean times or when emergencies arise is a key feature of whole life insurance policies. Too often, small business owners, especially those operating out of the home with low overhead, assume they have little need for emergency savings in their business. But any company, regardless of size, could run into cash flow-sabotaging issues such as:
- a product recall
- late-paying clients
- loss of a key client or distributor
- necessary technological upgrades
- an economic downturn, or other unforeseen occurrences.
When the Great Depression threatened to wipe out businesses, James Cash Penney used his whole life insurance policy cash value to meet payroll and other expenses. The liquidity it provided him literally saved the department store, allowing it to survive when others failed.
In the Great Recession of 2009 and later, our own cash flow suffered as investors struggled with both massive stock market and real estate losses. We were grateful to have liquidity that we had built up in our policies during that time.
Creditworthiness. Another way that life insurance helps cash flow management is by improving the credit-worthiness of a business owner, or even the corporation itself. While the policyowner (an individual or a corporation) can always borrow against their cash value directly from the life insurance company, as we noted in a recent post, a policy’s cash value can also be used to obtain loans at preferred rates… from a bank! See “Collateral Assignment: Banking on Your Life Insurance Policy” for details.
Lending institutions look for business loans to be repaid from the operating profits. Additionally, they want to know that borrowers have other assets to fall back on should the business cash flow falter or fail to commence to protect their interest. Life insurance cash value is an asset that can factor favorably into a lending decision. It demonstrates financial stability and can even be used as collateral for a loan.
Life insurance is often also a requirement of business loans, such as many SBA (Small Business Administration) loans. Term or permanent works in this case, as the objective is to ensure the debt for the term of the loan.
- Financing Capital Expenditures.
A friend of ours lives in North Dakota, and many of his insurance clients are farmers. He shared with us that farmers often pay 18%, 22%, or even higher rates for equipment loans. When these farmers learned they could insure their income and families while building cash value that they can leverage for loans at much lower rates, our friend became their hero!
As an added bonus, when business owners utilize life insurance loans to finance equipment or other capital expenditures, they never have to worry about loan qualification, credit scores, or paying exorbitant rates. (Currently fixed rates from life insurance companies are about 8%, adjustable rates are currently lower, though we personally prefer policies with fixed rates.)
From tractors and combines to new computer systems to cash flow crunches, life insurance cash value provides greatly enhanced liquidity and financial flexibility for business owners.
- Providing Employee Benefits.
The top problem identified by small business owners is that of finding (and keeping) the right employees. An attractive benefit package can help a business secure and keep top talent.
Life insurance can be used to fund employee benefits in various ways, thus helping business owners attract and retain high-quality employees.
Life insurance benefits. Executives often desire higher death benefit protection for their families, so life insurance can be a part of an appealing benefit package. Split dollar-life insurance policies allow companies to offer life insurance as a benefit to employees while recouping their premium outlay.
While an employer cannot discriminate who can or can’t have a 401(k), except in broad strokes (such as full-time vs. part time, or employees that have been with the company a certain length of time), employers CAN selectively choose who is offered life insurance benefits.
Non-qualified deferred compensation and SERPs. Life insurance is also often used to offer deferred compensation and other benefits to executives and other employees. NQDC (non-qualified deferred compensation) plans generally use the contributions of the employees. SERPs are supplemental Executive Retirement Plans typically funded by the company. Both can help employers attract, retain, motivate and reward key executives.
The benefit of a SERP or NQDC plan for the business owner? As with life insurance benefits, these plans can be used to provide benefits or compensation for key executives and employees. Additionally, non-qualified plans are not subject to the same vesting requirements as qualified plans. While bonuses, qualified retirement plans, and stock options are popular choices, deferred vesting options offer a compelling incentive for employees to stay on board for the long term. (They also do so without diluting company stock, an important consideration in some corporations.)
In “The Top 10 Uses of Life Insurance in a Family Business Succession Plan,” an article by estate planning author, expert and attorney Julius H. Giarmarco, Esq., Giarmarco discusses some of the benefits of nonqualified deferred compensation plans:
A nonqualified deferred compensation (NQDC) plan can be used by a small business to provide members of the senior generation with death, disability, and retirement benefits. A NQDC plan may be particularly useful in situations where the senior members have transitioned the business to the junior members and are no longer receiving compensation. A NQDC plan also ensures that key employees remain with the business during the transition period — a so-called “golden handcuff.” Because life insurance offers tax-deferred cash value growth and tax-free death benefits, it is the most popular vehicle for informally funding NQDC plan liabilities.
Non-qualified retirement plans also have greater flexibility, in general, than qualified retirement plans. Plans can even be designed to meet the unique needs of a specific company or executive.
But perhaps the most compelling reason that employers choose non-qualified retirement plans is the reliability and affordability of using life insurance to fund employee benefits. Not only do life insurance companies offer less volatility than stock-driven plans, but the internal rates of return often compete handily with other funding vehicles.
As Peter N. Katz states in his white paper, “Why Life Insurance is a Popular Funding Vehicle for Non-Qualified Retirement Plans, ” Life insurance is widely used as an informal funding vehicle because it can lower the plan’s cost. Many corporate decision-makers have concluded that, in addition to providing a life insurance benefit, the tax advantages of life insurance can produce higher after tax internal rates of return than other funding approaches.”
Is It Time for Your Business to Start Benefitting from Life Insurance?
As you can see, life insurance for business owners can fulfill many purposes! Contact us at Partners for Prosperity to obtain a policy quote and discuss how life insurance can help your business. Kim Butler has more than 20 years’ experience helping business owners with their unique financial needs using life insurance strategies and alternative investments that are non-correlated to the stock market.
Life insurance is much, much more than “death insurance.” See Kim Butler’s best selling little life insurance book, Live Your Life Insurance, for many examples of how you can use the living benefits of life insurance in both your personal and business life.