Life Insurance for Business, the Ultimate Guide
It does not matter how big or small a business is, every owner needs to have a succession plan in place. While most times it is out of ignorance, some business owners genuinely do not know how important life insurance for their business is.
A business life insurance plan is meant to protect the business itself, employees, the owner, and shareholders/partners. It all depends on the kind of plan you choose and the financial needs you have. The employer sets up a business life insurance policy by purchasing coverage for his/her employees.
The business can use life insurance in different ways like setting up benefit programs for the employees which include group plans. The business owner can use the life insurance plan to finance future uncertainties and the business does not have to come to an end when the owner or a key person dies. That is why it is vital to have a life insurance plan for your business.
This guide will help you understand the different uses of business life insurance and why it is important for a business to get one.
Business uses for life insurance
Business owners can leverage life insurance to support the life of the business and get through tough financial times. The following are ways in which businesses use life insurance to their advantage.
For the business
Life insurance plans can be used for the benefit of the business as an entity, and the following are reasons why owners should have it.
Cash value accumulation
Most life insurance plans allow for cash value accumulation during the life of the policy. With this, businesses can use the accumulated cash value to manage financial emergencies and income replacement in the future.
The cash value accumulated can also be used to pay debts that the business cannot afford to foot when in a bad financial status.
However, not all life insurance products have a cash value accumulation function so it is up to the owner to do their homework to be able to differentiate between the packages that do have with those that don’t have. Also, just because a plan accumulates cash value, it does not mean that it is suitable for your business.
The best thing to do is to assess your current financial status and your future financial needs before making a decision.
Guaranteeing a business loan
Businesses can also use life insurance to help get approval for a loan. Banks will require a business owner to set up a life insurance plan to be used as collateral for the loan. This way, the risk of lending to the business is low since the proceeds from the policy will be used to clear the loan. Even after the policyholder passes away, the insurance company will pay the remaining loan balance with the proceeds from the policy before transferring the remainder to the beneficiary.
Also, the business owner can use one policy to acquire more than one loan, as long as there is approval from the creditor and the insurer.
This is often the case for SBA loans, if you’re looking to get an SBA loan in place, you will need to get coverage.
For a buy-sell agreement
A buy-sell agreement ensures continuity of the business, even after a shareholder or partner of the business passes away. Businesses use buy-sell agreements as to succession plans and are meant to enable the company to buy shares of a deceased partner using the proceeds from the policy.
With a permanent cash value insurance plan, the business owner can use the accumulated cash value to buy the shares of a retired, disabled or deceased partner. In addition, for buy-sell agreements, different policy methods can be used for different types of businesses.
For developing a tax strategy
Generally, the use of life insurance in business can help the owner to develop different tax strategy opportunities. Similarly, you should carry out careful planning because the result of that may be negative, and you might be left with serious tax consequences. These consequences may lead to the downfall of any business, whether established or new, so it is important to have all the right information and strategies set in place.
What to get
While the uses of life insurance for businesses are clear, the business should be able to determine what products to get. For instance, when setting up a buy-sell agreement, a business can choose different agreements.
With a cross-purchase agreement, the partners of the business should set up policies for each of the other partners. In such a way that if one partner dies, the benefits from the policy go to the other partner. This way, both partners will be able to buy the shares of their deceased partner in case one of them dies. The cross-purchase agreements may not work very well for more than two partners because the higher their number, the more complicated it gets.
The entity method agreements can be used by businesses with more than two partners. In these agreements, the business buys policies on behalf of all the partners. This way, each partner does not have to go through the trouble of buying policies on all of the other partners. The business, being the beneficiary of entity method insurance plans is then able to use death benefits from the policy to buy interests of a shareholder in the event of their death, exit or if they are disabled and incapacitated. The entity method is also referred to as stock redemption and is most suitable with multiple partners or shareholders in a corporation.
For key employees
Key employees and executives in the business are hard to replace. These are the individuals responsible for driving the business towards its goals. For a business to achieve success and stay on top of its game, there must be dedicated employees adding value to the business. In most cases, these are usually executives who make major company decisions, and these are some of the reasons why you need insurance plans for key employees in the business.
Recruiting and retaining employees
If an employee is a driving force of the business and adds value to it, then there is a need to retain them. As the business owner, you need to treat such an employee as an asset and find ways of nurturing and keeping them for as long as the business stays. Life insurance plans for key employees are a form of incentive to such employees. Also, if your business has insurance policies to offer, then it is going to attract the kind of employees it wants and retain them in the company.
Rewarding key employees
Also, another reason why you should get a business life insurance is to reward key employees in your business. Numerous studies have proven that employees get motivated if they feel appreciated for their work. Life insurance can be a great reward for key employees in the business, considering they can use the policies as their retirement plans as well as enjoy other benefits that come with it.
Also, there are different plans for these key employees as shown below;
While split dollar is not a type of life insurance, a business can use this method to utilize survivorship life insurance, whole life insurance or universal life insurance. Split dollar can be explained as an agreement that dictates how the insurance contract will be shared between the business owner and their employee.
Components to be decided on with a split dollar agreement include the cash value, premiums, ownership, and death benefits. The split dollar agreement works in two ways;
The endorsed split dollar where the employer pays for all the premiums and the collateral assignment split dollar where the employee gets loans from the employer to pay for the premiums.
An executive bonus plan allows the business owner to choose an employee in their firm and provide supplemental benefits to them. The employee can use these benefits as their retirement plan since they are provided in cash accumulation and death benefits from the policy.
The executive bonus can be classified into the restricted executive bonus or the double bonus agreement. With the double bonus arrangement, the key executive does not need to spend their cash on the policy since it offers a bonus big enough to pay for the life insurance premiums. On the other hand, a restricted or controlled executive bonus limits the cash value benefits available to the executive until they fulfill terms drawn in their agreement.
Non-qualified deferred compensation
Also abbreviated as NQDC, it is an agreement where the employer agrees to compensate his/her employee later in the future. While nonqualified deferred compensation plans are common, there are also qualified deferred compensation plans, and the two differ with regard to the laws surrounding them and how people use them.
Qualified deferred compensation plans have strict regulations by Erisa while NQDC plans have rules that are not as strict. Also, NQDC plans do not have contribution caps but qualified deferred compensation plans come with income caps.
To protect owner/assets
Business life insurance is vital for every business owner that wants to protect both personal and business assets. The future is unpredictable, and you may risk losing everything you have worked for. Even in your absence, will things run as they are while you are alive? Will all bills, debts, and estate taxes be paid on time? Or do you risk losing them to creditors after you have passed away?
Life insurance will help ensure that these personal expenses are paid for and in the long run it helps to protect all your assets. Also, the death benefits can be used to pay for your funeral and burial expenses, costs which can range from $8,000 to $12,000.
Mortgage payments are also another issue for business owners. Your insurer will use the death benefits from the policy to pay your mortgage if you die before the loan is fully paid. This will save your house and prevent losing it to the bank or other creditors due to unpaid mortgages.
Also, business debts can lead to the loss of business assets to the creditor and in the worst-case scenario may leave you bankrupt. No one wants to be dead and bankrupt at the same time. Having a business life insurance plan in place will ensure that your assets are untouched and settle any debts you may have.
You don’t need a future financial obligation in order to get a business life insurance policy. Some business owners use life insurance plans to leave a legacy to a loved one or even as an act of charity where their beneficiary could be a charity organisation or an equivalent.
What to get
If you plan on running your business until a specific time, you can get a term life insurance plan to cover you until then. If you have taken out a mortgage, you can assign your life insurance policy as its collateral. This way, the mortgage will be paid back on time protecting your property from the bank.
If you have a family that is dependent on you, then a life insurance policy will not only help to protect your business but also them. You don’t want to leave your loved ones with financial burdens ranging from debts, outstanding bills, funeral expenses, estate taxes, and unpaid mortgages, just to mention a few.
Without a plan to pay for these expenses, your family will be left to carry all these burdens. It will be difficult for them to manage such expenses and still support the kind of lifestyle they had before. A life insurance policy will continue to support their lifestyle after your death and help them to comfortably pay any expenses and debts left at the event of your death.
What to get
Survivorship life insurance can help you can leave a legacy to your loved ones. If it is a family business that you co-own with your partner, both of you will need to take out one insurance policy, instead of two. The insurance pays out the benefits to the listed beneficiaries only after the two of you pass away.
So, a survivorship plan would be great for spouses who wish to continue supporting their families even after dying. This is an affordable way of locking life insurance than when compared to having different policies for two spouses but on the downside, the payout is only done when the two of you pass away.
Also, if you don’t trust your partner to pay the premiums should you die first, a single premium second to die or paid-up life insurance would be a great option. This way, no premiums will need to be paid in the future as the death benefit will be already secured.
However, if your spouse will have a need to replace your income, you may want to consider getting individual policies.
For employees (group coverage)
Group life insurance can be explained as one insurance contract that is meant to cover a whole group of people. The employee can choose to get covered by their employer or a labor organization, which is regarded as an external entity. In this case, both the employer and the entity are the policyholders and have control over the insurance plan.
The insured, who is the employee receives part of a whole benefits package and he/she will pay way less than they would have paid for an equivalent amount of coverage for individual insurance plans. This is a great option if your personal cover is not enough or if you don’t have any set in place.
With group coverage, the insurance policy is also known as the master contract and should be kept by the policyholder. A certificate of insurance is given to the covered employees to act as physical proof of the insurance plan. The certificate will not serve as the actual insurance policy, but the insured individual possesses the right to choose the beneficiary they want, just like with personal insurance covers.
In most cases, group life plans use term life insurance and the policy is renewable every year. If you choose to get group life insurance through your employer, then they will be responsible for paying most of the premiums, and in some cases, they pay all. The coverage you qualify for will be multiple, which could be one or two, of what you earn yearly.
Unless your term of coverage or employment comes to an end the group life insurance policy will stay in force. Also, if you decide to leave your current employer then you can convert the group policy into individual coverage but on the downside, the premiums you pay for such a conversion will be extremely high. This is why most people choose to get new plans because the conversion premiums are discouraging.
What to get
Life insurance for employees also provides group coverage for them for different reasons. This could be at the event of the death of an employee due to illness or an accident. Also, employees can get coverage if the get permanent disability or if diagnosed with a critical illness. Depending on the insurer, the terms and rates may be different but the policy will only cover for the employee if the above occurs while they are in employment.
The amount of cover an employee can receive can be a multiple of what their basic salary is in a year.
What you should do is use your group coverage as a supplement to an individual policy.
Types of Life Insurance for Business
When taking out individual life insurance coverage, you will have two main options to choose from, permanent life insurance which can be broken down into universal and whole life insurance, and term life insurance. This is the same case for life insurance for businesses.
Term Life Insurance
With term life insurance, the policy expires after the agreed period of time lapses, after which the insured individual is allowed to renew it every year. It is important to note that after the renewal, the premiums are subject to annual increments. Term life insurance enables the business to lock in a policy meant for a specific cover like a loan and as soon as it is fully paid, the business owner stops paying the premiums. Also, term life insurance can best be used when needed to get coverage for small business loans.
Permanent Life Insurance
On the other hand, whole life insurance and universal life insurance policies are used to provide coverage for longer periods than term life insurance plans can. That is why they are referred to as permanent life insurance plans, as they offer lifelong coverage.
Whole life insurance comes with many benefits with one of the most common being cash value accumulation. This means that the policy allows for the accumulation of cash all through the life of the plan. Apart from that, whole life insurance plans also offer death benefit and guaranteed premiums, with a few exceptions of dividend payment.
Universal life insurance, on the other hand, has different classifications with the most popular purchase being the guaranteed universal life insurance to age 121. With such a policy, the business owner will pay a fixed premium and get coverage for the rest of their life. Also, to age 121 is the best option if you need a cheap permanent insurance policy.
Another form of universal life insurance is the indexed universal life insurance which differs a little from the GUL policy. What sets the IUL apart from GUL is that the cash value accumulated is usually more for the 121 policies. This accumulated cash value can be borrowed against in case the business owner may need to borrow a loan.
It cannot be stressed enough how important life insurance is for businesses, and regardless of the size or nature, any business with a business life insurance plan in place will, without a doubt, be ahead of one that does not have. Having a business life insurance is vital for planning and keeping the business afloat in spite of financial blows and hardships it may encounter.
The good news for you is we are business life insurance experts. We can shop around on your behalf to ensure that you get the best rates, and it won’t cost you extra time or money. Give us a call today or run quotes on this very page.