The second blog in our series, Top 6 Reasons Why Smart Business Owners Use Life Insurance, talks about the importance life insurance has when it comes to protecting the owner's family and ensuring the survival of the business.
#2 Protect an Owner's Family and Ensure Survival of the Business
If there is a sole owner, it is likely that his or her departure from the business will cause in a significant decrease in its market value. Insuring the owner for the value of the business while he or she is still there will ensure that his or her beneficiaries will be able to reap the economic benefits that the company was expected to provide in the future.
If there is more than one owner, a buy-sell agreement should certainly be considered. This is a legally binding contract which states that, at an owner’s death, disability, retirement or separation from the company, the owner’s interest in the company must be sold back to the business or to the remaining owners at agreed upon terms.
Buy-sell agreements are crucial for small and closely-held companies where, as in many cases, the death or disability of a business owner creates a significant financial burden on the family, the business, and the remaining owners. They guarantee a market and a fair price for the business interests, ensure control over the business by the remaining owners, and can set the value of the business interest for estate tax purposes.
Life insurance on each owner is the most common and cost-effective way to provide the cash necessary for the business or the surviving owners to purchase a deceased owner’s interest.
Life insurance death benefits are typically paid income tax-free and in a lump sum to the entity or the surviving owners. In many instances, the cash surrender value in a permanent life insurance policy can also be accessed tax-free via policy loans and withdrawals to help pay for a lifetime purchase of a business owner’s interest, such as due to retirement or disability.
Depending on the type of buy-sell agreement, the business itself or the individual owners acquire a policy on each owner so that at separation from service, the funds needed to “buy out” the deceased owner’s interest are readily available.
In part three of our blog series, we discuss the importance of accumulating assets outside of the business for retirement with life insurance.