Using Life Insurance to Protect Your Business

succession planning

Running a successful business involves many moving parts. For example, it often takes a team of people with various skills to start and grow a company. Many of these people are essential to the functioning of the business, such as a founding partner, a high-level executive, or a top-performing salesperson. What would happen to the company if one of these critical people suddenly passed away?

Planning for the unexpected departure of influential employees is a necessary part of succession planning for businesses of all sizes. Business owners should keep several types of corporate life insurance policies in mind when planning for the future. Life insurance is a working financial instrument that can adapt over time to protect your business, your co-owner or partner, your customers, and your family in the event of your death.

Unfortunately, many business owners purchase a life insurance policy and file it away, never looking at it again. As your business evolves and its value increases, your priorities will likely change. It is best practice to revisit your insurance policies every few years to reevaluate the purpose of the insurance and the amount needed. Most policies are also more complex than many realize. They may include provisions that will provide enhanced flexibility to the owner and the insured, for example, the ability to modify the policy to fit your needs later in time. As people get older, their health and medical needs shift over time. As a result, coverage will get more expensive and difficult to maintain, so it is essential to consider covering the key people of your business as early as possible.

Key Person Insurance

Key person insurance, also known as key man insurance, is designed to provide financial protection for a business if a key employee dies. The benefit can help the company cover unforeseen costs such as losing clients or revenue, hiring a replacement, and other increased expenses in the wake of the key employee’s death. In this type of corporate life insurance, the business is both the owner and the beneficiary. They must receive permission from the employee to take out the policy. Two types of policies are available: term life insurance and whole life insurance. Selecting the correct type of plan and understanding the contract terms and provisions is crucial as they will have profound long-term implications for the business.

Term life insurance covers a defined period, usually up to around 30 years. Whole life covers the business for the employee’s entire life and can accumulate cash value, but it is much more costly to purchase. In many cases, term life insurance is appropriate and offers the right business coverage. The situation becomes more complicated when the business has a critical employee who is getting older and has medical conditions but still requires coverage. For example, if the president of a company has worked there for many years, his presence is incredibly valuable to the company, and his death would result in significant losses. The problem is that he has developed diabetes, and getting a new life insurance policy would be prohibitively expensive.

Most term life insurance policies include conversion provisions, which allow the policy to be converted from term life to permanent life insurance without going through the underwriting and medical exam process again. Some guidelines have a specified term conversion period, meaning you can only convert the policy for a certain number of years, while others will allow conversion at any time. Suppose you work with a knowledgeable insurance broker to set up your policies and review them regularly. In that case, you can maintain coverage for the most important people in your business for as long as they plan on working.

Buy-Sell Agreements

Buy-sell agreements are another way to ensure your business and your loved ones are provided for in the case of an untimely death. A buy-sell agreement is a contract that outlines what will happen to the business and how the transfer of ownership will take place in the case of a triggering event. There are many ways to set up a buy-sell agreement, but one standard method is to use life insurance to fund the purchase of the deceased owner’s business interests. In a cross-purchase plan, the surviving partner receives the benefit (usually income-tax-free) of buying out the partner’s portion of the business, preventing any possible issues or competing agendas with the deceased partner’s remaining family. This also provides the family with liquidity to cover expenses. Alternatively, entity purchase agreements allow the business itself to purchase the deceased owner’s interests. The business benefits from the policy and receives the death benefit to buy the owner’s shares. Different types of buy-sell agreements also carry other tax implications, so it is essential to work closely with your financial team and broker to write an agreement that meets your needs, uses suitable valuation formulas, and minimizes future taxation.

Consequences of Not Having a Plan in Place

Higher tax rates are just one consequence that businesses may suffer without proper succession planning and insurance plans. If an owner or essential employee dies, the business could sustain considerable financial losses and not receive any payout to help offset these costs. In addition, ownership and leadership transitions can turn chaotic as different people have diverging goals for the company and their shares. Surviving partners may suddenly find themselves in business with a spouse or heir of the deceased who wants to sell the company.

These scenarios may seem overwhelming, but it is quite simple to put agreements and insurance policies in place that will protect your business and your family. Discussing corporate life insurance may feel like something other than a high-priority item when you are busy with day-to-day operations. Still, it will directly affect your legacy and your company’s success if something happens to you. Talking to an insurance expert to create and routinely reevaluate life insurance policies will ensure that you are maximizing all options available. As soon as you can identify risk, it would be best if you begin to cover it. Whether you are just starting a partnership or growing the family business, get started with the right insurance now. The expert team at Henderson Brothers can guide you through coverage options and policy selection so you can be as prepared as possible for the unexpected.

Please note that the information contained in this posting is designed to provide general awareness in regard to the subject matter covered. It is not provided as legal, medical, or tax advice, nor is it intended to address all concerns in your workplace or for public health. No representation is made as to the sufficiency for your specific company’s needs. This post should be reviewed by your legal counsel or tax consultant before use.