Very few people say they love buying or the process of purchasing life insurance. Who wants to discuss the eventual demise of oneself? Certain situations rely upon life insurance to create an insurgency of cash into a business when weathering the loss of a business owner. There are, however, clever uses of life insurance by business owners that are predicated upon more than the business owner’s unfortunate and untimely death.
Here is a sampling of clever uses of life insurance, and if there’s ever been a reason to get excited about life insurance, this may help.
Tax Effective Planning:
Over-funding a permanent life insurance policy is a great vehicle to protect one’s business and a very efficient way to get retained earnings out of your business. The cash value within an insurance policy grows tax-free, and if you correctly access the cash, you can get the money into your hands personally tax-free. This can take several forms, most commonly as an Insured Retirement Plan.
Key Employee Retention:
Keyperson insurance has always been a fundamental purpose of life insurance. In the past, this has been achieved mainly by term insurance. By putting a deferred bonus of a key employee into a permanent life insurance policy, the business can be protected in the event of a sudden loss of a key employee. If structured correctly can act as an incentive for the employee to stay for a prescribed period and receive the cash value within the policy.
Obtaining Third-Party Financing:
Life insurance can act as a superb vehicle to get money out of your business, and the cash value within a permanent policy can also be used as collateral at a third-party financial institution. The cash value can be used to finance capital expenditures, acquisitions or act as an insurgence of capital into a business. Depending upon the type of policy, up to 95% of the cash value can be leveraged for this purpose.
Since insurance is unique in how it must assign a designated beneficiary (whether in a life insurance policy or a segregated fund), insurance can serve to creditor protect a business’s assets. This is more effective within a personally-held life insurance policy or segregated fund versus a policy held by a corporation because of the designated beneficiary.
Equalization for Children Inside or Outside the Business:
Many business owners face a challenge: how do you divide up your assets evenly with your children? In the event of a business it’s challenging. How do you create fairness and equality if one child decides to work within the family business and other children decide to take another path? A child working within the company may be a natural successor, but how do you compensate the children that take a different career path? Setting up a permanent life insurance policy for those children outside the business will help to mitigate any controversy that may arise and any huge disparity that may exist. It’s not uncommon to see lawsuits for unfair compensation between family members. If the business can weather the ensuing legal battle, the family members may be forever estranged.
The same concept can apply to internally led succession strategies in the same way life insurance can help retain key employees. Purchasing a permanent life insurance policy in the name of the successor can help an individual come up with a sum of cash that could act as a deposit or initial payment in an employee lead buyout. These strategies do require time to facilitate.
If you are looking at an internal or family buyout of your business, the founder may elect to do a share freeze so the shares’ value does not become unaffordable. This involves establishing a separate class of shares for the future owners. The company’s value continues to increase, but the prospective owners do not need to bear the increased value. Those increases are included in the founder’s class shares and will need to be paid at the time of the sale. Life insurance can help to cover the capital gains taxes that are owed.
Minimizing Taxes When Selling Your Business:
Selling your business can represent the single largest tax event for most business owners. This can translate into a significant cheque written to CRA for capital gains taxes. This can represent hundreds of thousands or even millions of dollars. Alternatively, you can use strategic philanthropy to minimize your tax burden. The most efficient way to do this is by designating a charity as the beneficiary of a life insurance policy.
Protecting Rapidly Growing and Start-Up Companies:
One of the challenges with protecting a business from the unexpected death of a shareholder is figuring out how much insurance to have in the event of the loss of a shareholder. This is a more significant challenge, especially if the company is a start-up or going through rapid growth. You can always apply for additional coverage; however, what happens if the shareholder becomes uninsurable? One of the advantages of a permanent life insurance policy is its ability for growth of cash value but also an ever-increasing death benefit. All too often, I’ve seen shareholders covered for a million dollars, but the value of their shares is ten times the insurance coverage. This is common in start-up companies or businesses undergoing exponential growth periods. What would happen to the business in the event of the untimely death of a shareholder when they are grossly under-insured?
Traditionally, businesses have bought insurance to facilitate buy-sell agreements and protect the company from the sudden loss of key personnel, which are still of fundamental importance. These life insurance policies can preserve an organization’s and its employees’ longevity or satisfy Partnership Agreements. Let’s remember the clever uses of life insurance and the many strategic opportunities for wealth building, tax-effectiveness, retirement planning, estate planning, building and protecting multi-generational wealth and preventing potential inter-family dispute resolution.