Life Insurance for Business
Estate planning should be started early and updated frequently.
Does your farm or business have a succession plan? Is there a procedure to follow if one of the owners unexpectedly dies? Have you positioned your farm or business to avoid death taxes? At Phillips Stafford Insurance Group we work with our clients, as well as their legal and accounting advisors, to craft a plan for not only the unexpected departure of an owner but also the expected.
Farm and Business Succession Planning
Have you prepared for your inevitable departure from your business? Have you clearly communicated your plan to your family? Sometimes communicating the plan isn’t enough. Putting together a formal document, after discussing the plans with your family, is the best option. Estate planning may seem uncomfortable, but it is a necessity.
We have personally experienced family division due to poor estate planning. We can bring experts to the table to help guide and consult you and your family when it comes to fairly transitioning your business to the next generation. We can also implement strategies to avoid an estate tax issue that has forced many family businesses and farms to sell significant assets and even entire operations just to pay the tax bill. Adequate estate planning now will assure that the business or farm you spent your life building will go to the person you choose, not Uncle Sam.
A common buy-sell agreement will state that, upon the death of a business owner, his or her shares will pass to their heirs. The heirs, who have also signed the buy-sell agreement, have an obligation to then sell the shares back to the company for a price determined in the buy-sell agreement. This price is often calculated and agreed to annually. One of the biggest mistakes made is stopping right there. How will a business, especially one that just lost a key-person, pay to buy the shares from the heir?
Let’s look at a business with two owners that is projected to be worth $1,000,000 in 20 years. The business has three options:
- Option 1: Start saving money now – This may seem like an easy solution, just put some money aside in the business each month to build a pot of money to be used to buy the shares of a deceased owner. After 20 years of saving $2,000 per month the business would have nearly $500,000 they could use to buy the shares of the deceased owner. But what if an owner dies in year 5. The business would only have about $120,000. If the deceased business partner’s shares are valued at more than $120,000 where will the additional money come from? Will the business have to sell assets?
- Option 2: Get a bank loan when an owner dies – First, let’s assume that a bank will even loan the business an amount equal to half the value of the business after a key-person has just passed away. If you get past that hurdle, the business will then take on a large loan payment, with interest, right after losing a key-person. Let’s assume a 10 year loan for $500,000 is received at a 6% interest rate. The business will have monthly payments of $5,550 and will end up paying back a total of $666,000 over ten years. Sounds like a pretty sweet deal for the bank.
- Option 3: Proactively purchase life insurance – For as little as $42 per month the business can purchase two 20 year term life insurance policies with a $500,000 death benefit. This can be structured as either a Cross-Purchase or an Entity Purchase. Then, if an owner dies the next day or in 20 years, the business is covered. As an added bonus, in the early years when the business shares aren’t worth $500,000 the additional death benefit can be earmarked as key-person insurance to help keep the business going. After 20 years the business will have only spent $10,560 for this protection. A drop in the bucket when compared to the other options.
Buy-sell funding using life insurance is the best way to fund a buy-sell agreement. Life insurance policies should be purchased on each business owner. The death benefit of the policy should be the value, or projected future value, of that owner’s shares in the business. This guarantees that there will be enough money to purchase the shares back from the heirs without any undue hardship on the company. Think of a buy-sell agreement as business estate planning. A business is a person in the eyes of the government. Just as much attention should be paid to the business’s financial affairs as an individual’s.
Does your business have someone, maybe even yourself, who’s absence would financially hurt the company? Does your company have the funds to start the costly process of searching for an executive employee or to pay a substantial salary if they need to bring in a non-owner? Key Person insurance coverage can help mitigate that risk.
It’s common for business to take out life insurance policies on their employees for just this reason. Replacing someone, especially a key-person that is suddenly lost, can be very costly. However, since the company owns the policy there are some regulations that need to be followed. Phillips Stafford Insurance Group has experience placing policies like this. We know what regulations need to be followed and how to place a solid policy that meets the regulatory guidelines.