Working with Business Owners Is as Easy as 1-2-3!
Small business is the backbone of America. These small businesses are valuable assets to their owners, but many owners aren’t aware of the opportunities to build, protect and enhance themselves with life insurance.
The majority of business life insurance cases can be developed taking a three-step approach.Working with Business Owners Is as Easy as 1-2-3!
Working with Business Owners as is Easy as 1-2-3! By David Szeremet, JD, CLU, ChFC
Here is a three-step process that will help keep you focused and on track when developing business life insurance cases.
Small business is the backbone of America. There are more than 28 million small businesses in this country, a number that has grown by 49 percent since 1982.1 These small businesses are valuable assets to their owners, but many owners aren’t aware of the opportunities to build, protect and enhance themselves with life insurance.
The majority of business life insurance cases can be developed taking a three-step approach.
One: Protecting the Business and Ownership Team
Most small businesses can identify some employees as "key" to the organization’s ongoing success. These individuals possess unique skills, expertise, decision-making power and vision. Their unplanned absence can disrupt a company’s earnings, productivity and morale.
A key person life insurance policy protects against losses as a result of the death of a key person at your business. The policy’s death benefit provides capital to help the company absorb the absence of the key person. Unlike other sources of capital, such as a sinking fund, a loan or company earnings, life insurance provides liquidity precisely when the need arises — upon the death of a key person. Further, optional riders are available that can waive premium payments in the event of the insured’s total inability to work due to disability. Upon the key person’s retirement, the company may decide to sell or bonus the policy to the insured, surrender the policy or simply keep it in force.
Not to be overlooked, business overhead insurance may be an excellent vehicle to cover fixed business expenses during a period of disability for an owner.
Two: Business Succession Planning
Once the key protection elements are in place, most business owners turn to business succession planning. The statistics don’t lie: 78 percent of small business owners plan to sell their businesses to fund their retirement, but only 30 percent have a written succession plan.2 This is an excellent opportunity for you as a financial professional to propose a buy-sell agreement as a funded exit strategy. In the event of retirement, death or disability, this can help small business owners harvest the value of their business when they leave the company.
Through a buy-sell agreement, the business owner selects a buyer and determines the purchase price and the funding source for the future sale of their business. In addition to consulting with a tax professional before electing to execute a buy-sell plan, your clients should work with an attorney to draft a buy-sell agreement between the business owner and the projected buyer.
A buy-sell agreement is most commonly structured as either a cross-purchase or an entity-purchase arrangement:
- Cross-purchase approach. Individual business owners purchase life insurance policies on the lives of all other business owners. It generally works best when there are three or fewer business owners of relatively equal age and health status, all of whom can be depended upon to make timely premium payments. A cross-purchase approach may also provide the most favorable tax basis for the purchasing owners.
- Entity-purchase approach. The business purchases policies insuring the lives of each business owner. This strategy is simpler for businesses with more than three owners, and it equalizes premiums paid for individuals of varying ages and health classes. Although premiums are not tax-deductible to the business, the death proceeds are received income tax free, assuming IRS guidelines are met.
Life insurance is often an ideal funding source for a buy-sell agreement triggered by the death of a business partner, and it may be the most affordable option when compared to a bank loan, a sinking fund or an installment sale. The death benefit provides liquidity precisely when the need arises — upon the death of a business owner. Further, a permanent policy can accumulate cash value that can help fund a buy-out strategy upon retirement.
Three: Rewarding Top Talent
Small businesses create two out of every three new jobs in America3, and the ability to recruit, retain and reward outstanding talent is key to a small-business owner’s success. An executive bonus plan using permanent life insurance is a benefit that can help set up your small business owners to give them flexibility and options different from what they could offer with a qualified retirement plan. They choose the participants and can pay premiums in the form of a salary bonus.
After working with underwriting to determine an appropriate policy amount, the business pays the life insurance policy premium. Assuming the bonus is reasonable in amount, the business receives an income tax deduction, and the employee pays income tax on the bonus.
The employee is the owner of the policy and names a beneficiary. Assuming that permanent, cash value life insurance is purchased, the employee would have access to policy cash value, typically as a retirement supplement. The policy cash flow would be taxed in an appropriate manner depending on the nature and extent of the withdrawal. If potential cash flow will be part of the policy design, it is generally inadvisable to use a modified endowment contract due to the likelihood of adverse tax consequences. When the insured employee dies, life insurance proceeds, minus any loan amounts, are paid to the employee’s beneficiary income tax-free.
Using a three step approach to working with business owners helps keep you focused and on track. But always remember — it’s about what the client wants, not what you want for them.
David Szeremet, JD, CLU, ChFC, is second vice president, Advanced Planning, at Ohio National Financial Services based in Cincinnati, Ohio. Szeremet is responsible for the Advanced Planning team that provides estate planning, executive benefits, business insurance and life insurance planning. He can be reached at firstname.lastname@example.org or at 513.794.6389.
This article appeared in Advisor Today.