Not many people say they love buying or the process of buying life insurance. Who wants to discuss the eventual demise of oneself? There are certain situations which are reliant 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 are just 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 not only is a great vehicle to protect one’s business but also 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 in a tax-free way. This can take on several forms but most commonly as an Insured Retirement Plan.
Key Employee Retention:
Key person insurance has always been a fundamental purpose of life insurance. In the past, this has been largely achieved 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 but structured correctly can act as an incentive for the employee to stay for a prescribed period of time and receive the cash value within the policy.
Obtaining Third Party Financing:
Not only can life insurance act as a terrific vehicle to get money out of your business, depending upon the type, amount and age of a policy, but the cash value within a permanent policy can also be used as collateral at a third-party financial institution 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 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’ 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:
A challenge that many business owners face is 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 business may be a natural successor, but how do you compensate the children that take a different career path? By setting up a permanent life insurance policy for those children outside the business will help to mitigate against any controversy that may arise and any huge disparity that may exist. It’s not uncommon to see lawsuits that come from the unfair compensation between family members. If the business can weather the ensuing legal battle, the family members may be forever estranged.
In the same way that life insurance can help retain key employees, the same concept can apply for internally lead succession strategies. 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.
Paying Your Children Through Your Business:
Although the proposed changes by the Trudeau Liberals about taxation of small business owners have received much attention from the media and financial professionals, much of the conversation involves income splitting or sprinkling. This is not about family members receiving dividends from a business.
This is about children providing legitimate services to a family business and being compensated for services rendered. Money earned can be put into a permanent life insurance policy that over time can be a tremendous saving vehicle for children to attend college, purchase a home or fund retirement. The parent (i.e. business owner) is the owner of the policy and controls the distribution of the funds within the policy. At any point in the future, the parent can sign over the policy to the insured child.
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 problem can be compounded 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 not uncommon in start-up companies or businesses that have gone through 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 business from the sudden loss of key personnel which are still of fundamental importance. These life insurance policies can protect the longevity of an organization and its employees or satisfy Partnership Agreements. Let’s not forget about 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.
Chris Coulter is the Founder and President of The Finish Line Group. He works with business owners to leverage their businesses to increase their wealth, reduce corporate and personal taxes, create viable succession strategies, enable employee retention strategies and allow them to exit their businesses on their terms.
Chris’ passion for what he does evolve from the mistakes he made in his first business; by not diversifying his risk and not utilizing a lot of the opportunities within his business to create significant wealth. Chris found out the difficult way and now educates business owners on how to avoid many of his former oversights and ultimately control where their finish line ends.
Clever uses of life insurance