Business owners need life insurance. Many individuals purchase life insurance to cover the needs of their family but little else. However, the owner requires more coverage to ensure their loved ones remain protected on their passing. The policy or policies selected must cover both personal and organizational financial obligations upon the business owner’s passing. What does a person need to know when designing coverage for this unique set of needs?
Life Insurance to Cover Family Needs
A common approach is to consider term life insurance to cover the needs of family members who rely on income from the business. The amount purchased depended on these needs, and the purchaser decides how long the policy will remain in effect. However, if the business owner outlives the policy term, the death benefit no longer remains in effect. Individuals may renew the policy at this time, but the premiums increase as a person ages. Expect to pay a higher monthly premium when renewing a term life insurance policy after the original term period ends. Consider purchasing a permanent policy with a cash value component to ensure the coverage will remain in effect until it is needed by your family at the time of your passing.
Business Liability Coverage
A business owner might wish to leave their small business to family members or business partners when they pass. However, passing on the business also means passing on the associated financial obligations. Look into obtaining a policy with coverage sufficient to pay off these liabilities during the transition period. Doing so gives those left behind the opportunity to get the business back on track and bring in the same income you generated before passing.
Coverage in the Event of a Business Partner’s Passing
When individuals form a partnership, they often include a buyout clause in the agreement. This clause allows the surviving partners to purchase the deceased individual’s share from their estate. Often, the buy/sell clause includes a funding element, frequently using life insurance to create highly leveraged liquidity should an insured partner pass. The policy ensures the surviving partners have funds to buy the deceased partner’s share from their beneficiaries.
Term coverage is a possible approach but many partners choose to buy permanent life insurance. This type of policy comes with the expectation that the policyholder pays premiums until they pass. One benefit of choosing this option is that the policy accumulates cash values that earn interest. Upon the policyholder’s passing, the beneficiaries receive the death benefits as well as any accrued cash value.
With a permanent plan, when an individual disbands the partnership before their passing, they close the policy. This means that they will lose the policy’s death benefit but are able to claim any remaining cash values and accrued interest from the account. People often choose to make permanent life insurance a part of the buy/sell agreement in order to have more control and the appreciating cash value within the policy but these added benefits do mean that one must pay higher premiums in comparison to a term policy.
Key Employee Insurance
The loss of certain individuals within a company can have massive negative consequences. For instance, the company may employ a product development specialist. If this person were to pass with several projects unfinished, the business could suffer a significant setback. If this happens and the company has a key employee insurance policy, the funds lost because of their departure are replaced to the extent of the policy. As such, the policy proceeds provide the company with liquidity, which in turn translates to additional time to replace the specialist and get the projects up and running again. It is common to emphasize the use of term life insurance for key employees to keep costs down as there is no way to know how long they will remain with the company.
Additional Life Insurance Needs
A person may use life insurance for several other purposes following the death of a business owner. The policy may cover taxes that result from transferring ownership of the business. If the business has appreciated, the tax burden can be significant. The insurance policy helps to reduce or eliminate this burden.
Individuals left behind may use the funds to pay attorneys handling the estate. Legal representation becomes of great importance when some beneficiaries will become shareholders of the company while the deceased excluded other individuals. The attorneys ensure the transfer goes smoothly.
How Much Life Insurance is Needed?
Individuals wonder how much insurance they truly need. When purchasing a term life policy for family and business liabilities, determine the family’s expenses first. Calculate all debt, including the mortgage, income that needs to be replaced, and the cost of educating any minor children. This provides information on the amount of money the family will need upon the business owner’s passing.
Next, determine the short and long-term liabilities of the business. This list may include salaries, interest, and accounts payable along with investment taxes and other debts. This figure shows the amount that the business will need to cover upon the owner’s passing.
Add these two figures together to begin determining the amount of term life insurance required. However, speak with an insurance professional r to make certain all calculations are correct and nothing has been overlooked. Taking this extra step ensures the family has no surprises upon the business owner’s demise.
Buy/Sell Agreement Term Life Insurance
Before purchasing buy/sell agreement term life insurance, get a business valuation for a more accurate measure of how much coverage is needed. Take this figure and divide it by the number of business partners listed in the agreement. The resulting figure determines how much term life insurance will need to be purchased to cover the buy/sell agreement for one partner. Policies will be needed for each partner listed. However, consider other factors when making this purchase, such as the coverage length and conditions to ensure the policy will meet the needs of those left behind to fund the purchase.
Key Person Insurance
Make a list of all key employees within the organization. Determine how much money will be needed during the transition period if one or more of these individuals leave and a replacement must be found.
Small business owners must ensure their dependents are covered at the time of their death. Life insurance provides financial security during this challenging time and provides business partners with the means to purchase the deceased’s shares of the business when a buy/sell agreement is in place. Key employee insurance protects the business if an essential person leaves the organization. Ensure you have all areas of coverage to protect your interests and secure your financial future and that of your loved ones.