3 Powerful Life Insurance Strategies Business Owners Can Use to Protect and Grow Their Business
September is Life Insurance Awareness Month. Well, “great” you might say, “I am aware of life insurance, mission accomplished!” However, most people have only a cursory understanding of life insurance products and the role life insurance should play in their personal financial planning.
Some people may be minimally protected by a group term life plan offered by their employer. Others may have secured additional coverage through a voluntary buy up plan at work (think 1x, 2x, 3x salary). Some may have even secured individually underwritten coverage from a national carrier to provide a death benefit to a spouse or children. And a very few might have taken the time to research the potential tax savings and the retirement income potential offered by the many permanent products available like whole life, variable life, and/or universal life policies.
However, most business owners are totally unaware of the many life insurance strategies available to help them protect and grow their business. To help remedy this, we will address three potential business owner life insurance strategies in this month’s post; Buy-Sell Funding, Key Person Coverage, and Executive Compensation (i.e. “Golden Handcuff” plans).
Many multi-owner businesses have a Buy-Sell agreement in place which outlines what will happen should one owner become disabled or die. However, a surprising number of businesses have not established a way to fund these agreements. Life insurance is clearly the appropriate tool here. Adequate funding can be assured using a “cross purchase” agreement, where each owner purchases a life insurance policy on the other owner, relative to their percentage of ownership. When one owner dies, the resultant death benefit goes directly to the deceased owner’s heirs to satisfy the stipulations of the buy-sell agreement. Alternatively, this funding can be set up using an “entity purchase” agreement, where the company owns the insurance policies and receives any death benefits. These funds are then used by the company to satisfy the specific stipulations of the Buy-Sell agreement. Buy-Sell agreements are excellent protective strategies, and life insurance is often the only feasible method to fund them appropriately.
“Hah” you say, “I am a sole proprietor, I don’t need insurance to fund a buy-sell agreement.” If this is the case, then you are likely even more dependent on the protections offered by a life insurance policy. For if something happened to you, there would be no one left to ensure that your business is monetized appropriately with the financial benefits passing to your heirs. We call this variation of the agreement, the “one-way” buy sell, because the death benefit passes directly to your heirs, ensuring their financial wellbeing long after you are gone.
A second strategy often used by business owners to protect their business is Key Person life insurance coverage. If your business has a key employee whose loss would cause an outsized material or monetary loss, then you should certainly be considering purchasing a Key Person life insurance policy on that employee. These policies are often used to protect against the loss of a key executive, a highly skilled employee, or a salesperson driving significant sales revenue based on his/her personal network.
A Key Person life insurance policy is company owned with the key employee insured. Should something catastrophic happen to the key employee, the business will receive the death benefit. This death benefit can be used to find and replace that key employee or used to offset other forms of monetary loss that might arise in their absence. Some companies will use a split dollar arrangement in order to provide some benefit (cash value, loan features, or death benefit) directly to the key employee during their life.
A third, and final, strategy that business owners can use to grow and protect their business is to implement an Executive Bonus plan to retain top talent. Usually these “Golden Handcuff” plans are centered around a cash value insurance vehicle such as an Indexed Universal Life or Variable Universal Life insurance policy. Depending on the business structure (LLC, S-Corp, or C-Corp), and potential deferred compensation tax planning needs, these policies can be owned either by the company, or by the employee. If employee owned, the death benefit and cash value are often set up as split dollar arrangements or collaterally assigned to the company for a certain period of time.
The Executive Bonus plan premiums are paid by the employer, with tax benefits being enjoyed immediately, or on a deferred schedule. The death benefit, increasing cash value, and income will be enjoyed by the employee at a future date, based on performance targets and/or vesting requirements. This vesting schedule ensures that the key employee is incentivized to perform at their best and stay with the company for a set timeframe. The deeper into the scheduled vesting period, the harder it will be for a competitor to poach your key employee, because the employee will lose access to the deferred cash value and potential income accrued within the policy.
Almost every corporation in America is using some variation of a “Golden Handcuffs” plan to incentivize and retain their executive staff. Just because you are a small, or medium, sized business doesn’t mean you can’t do the same thing!
In conclusion, Life Insurance Awareness Month is a great time to do a comprehensive life insurance review and take a look at some strategies that might help you protect and grow your business! Whether you are a sole proprietor, a small LLC partnership, an S-Corp, or a C-Corp, there are strategies available to help you.
If you would like to learn more about any of these strategies, please reach out to us at info@edwardspencergroup.com or give us a call at (919) 925-3345. We look forward to speaking with you!