“Cash value life insurance plays a massive role in financial institutions, corporations and banks…. Not only does it increase their financial stability and reduce their taxes, it is an ideal place to fund employee pensions, healthcare costs, and other benefits.”
– Jake Thompson, Money. Wealth. Life Insurance.
Two weeks ago, we shared how you can use a life insurance policy’s cash value to obtain loans at preferred rates… from a bank! See our article, “Collateral Assignment: Banking on Your Life Insurance Policy,” for details.
Today, we’ll explore 5 ways that life insurance helps business owners solve some of their biggest challenges. But first, let’s set straight some myths about businesses and life insurance.
3 Myths About Life Insurance for Business Owners
Myth #1: Life Insurance is only for big businesses.
Fact: It is true that banks and corporations are big buyers of permanent life insurance (known respectively as “BOLI,” Bank-Owned Life Insurance, and “COLI,” Corporate-Owned Life Insurance.) But it’s a myth that life insurance can is only practical or advantageous for large businesses. Even very small businesses with less than 5 or 10 employees (such as Partners for Prosperity) can benefit greatly from life insurance!
Myth #2: Term Insurance is all you need.
Fact: Banks and corporations use permanent life insurance for a reason! While term insurance may have a proper place in your business as well as your personal financial strategy, permanent insurance provides important long-term benefits. When strategizing for long-term success, term insurance is almost always an expense to a company, while permanent insurance can provide both short and long-term liquidity, tax savings, and other benefits that can far outweigh the costs.
Myth #3: Only the business owner needs life insurance.
Fact: While every business owner can benefit from having life insurance, almost any business owner can multiply the benefits and the meaningful protections with multiple policies insuring partners and key employees. Let’s explore why insurance is an asset in business, helping business owners solve many of their top financial challenges.
Five Financial Concerns of Small Business Owners
Nearly 700 small business owners were interviewed by The Guardian Life Small Business Research Institute to determine the top ten challenges of small business owners. Five of those top financial concerns were extremely relevant to the solutions that life insurance can provide:
- 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).
We’ll explore the first two in this article and the remaining three in part 2.
- Planning for the Future.
There is perhaps no better financial product for long-term planning than life insurance. Life and business are both full of the unexpected, and wise business owners will be as well-prepared as they can be for any possibility. There are several ways life insurance can help with such strategies.
Succession Planning. A life insurance policy is often the cornerstone of a business’s succession plan. The business uses life insurance to fund a buy-sell agreement, allowing surviving partners to purchasing a deceased partner’s share of the business from their estate. In this way, surviving spouses and heirs receive their share of the business, and the living partner(s) maintain control of the business. Buy-sell agreements can reduce conflict and allow the business to keep running smoothly.
The accumulated policy cash value can also be used or leveraged to help one partner purchase another partner’s interest in the business, upon mutual agreement. A one-way buy-sell agreement can be constructed in cases when a chosen successor wishes to purchase the company upon a founder’s or partner’s retirement from the business.
Key Employee Policies. No business would think of not insuring their buildings and equipment, yet often, they don’t ensure its greatest asset – the people whose skills, knowledge and experience are essential to its operation!
Traditionally known as “key man” policies, life insurance policies taken by the business or business owner on a hard-to-replace employee are now referred to as key person or key employee policies. Examples could be:
- A company manager
- The head chef of a restaurant
- An organization’s top salesperson
- Any employee whose absence would cause a severe disruption of a business.
Jill has been with Partners for Prosperity for years, and we’re not sure what we’d do without her! She is also literally “part of the family,” my husband Todd’s aunt. The whole life policy we have on Jill also has a waiver of premium feature, which means that in case of disability, the premiums will continue to be paid by the life insurance company.
The policy provides our business with additional liquidity and savings that could be borrowed against in an emergency. The policy also benefits Jill and her husband. The policy would provide an additional income for her husband in the case that anything happened to Jill.
Pension Maximization. The policy also enabled Jill to choose a higher “single life” pension payout, should she survive her husband. This pension maximization strategy using life insurance can benefit couples as well as employees, and it can be used with social security payouts as well.
Estate Equalization. Often times, business owners will have several adult children who may have varying degrees of interest and involvement in the family business. When Brenda is a lawyer across the country but Brad is a manager in the family business and an obvious choice to take it over someday, how do you solve the estate planning dilemma? Life insurance provides the solution by creating an additional asset that can be used in a multi-generational balancing act.
As with personal life insurance, often a combination of term and whole life is a good solution. Even if someone aims to retire at a certain age or after a certain number of years, we highly suggest planning for flexibility since many people find they enjoy being active in business well into their 70’s and 80’s.
Interestingly, the research institute survey revealed that many small business owners already owned whole life policies, term policies, key employee policies, and insurance-funded buy-sell agreements. Yet in some cases, almost as many survey respondents “planned to acquire” such policies the following year. Of course, it’s always best to acquire the policies before they are needed, which may be sooner rather than later.
- Tax Minimization.
The tax-free growth of life insurance cash value is an attractive benefit to most companies, and one reason why banks and corporations fund permanent insurance policies. Cash value accounts grow tax-free while within the policy.
In a white paper entitled, “Why is Life Insurance a Popular Funding Vehicle for Nonqualified Retirement Plans?” attorney and insurance professional Peter N. Katz explains,
Like the individually owned annuity, cash value accumulations grow tax deferred. But life insurance has even greater tax benefits than an annuity in that accumulations can be accessed in a tax advantaged manner by withdrawing values to basis and then using loans. Using this approach, the cash values can be accessed free of income tax. For individual annuities, loans and withdrawals are treated as income distributions first, then basis. Going yet a step further, unlike the annuity where remaining values are taxed upon or shortly after death, life insurance death proceeds are generally received income tax free under IRC §101(a)(1).
This combination of tax factors can allow a life insurance policy to produce an internal rate of return that exceeds that of a taxable portfolio growing at a similar rate.
In some situations, life insurance premiums may even be deductible. (Consult your advisor and your accountant to understand fully the ins and outs of how life insurance policies may impact your taxes.)
Is It Time for Your Business to Start Benefitting from Life Insurance?
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, including life insurance solutions.