For most privately owned enterprises, the death, disability or retirement of a co-owner or key employee can directly impact the sustainability of the business. The loss of a co-owner or vital employee not only impacts short-term operations, it can have a dramatic impact on the viability of the company long term. Within this perspective, life insurance can be a multi-purpose financial tool to address key business issues of importance to both business owners and lenders to that business.
Planning for the future
Life and business are both full of the unexpected, and wise business owners will be as well-prepared as they can be for any possibility. Companies that have instituted succession plans ensure the stability of the business and bolster the confidence of business partners, vendors and bankers alike. The challenge is to develop a succession plan that satisfies each business owner’s desires to pass along assets to his/her heirs, while making sure the business is not negatively impacted.
Life insurance can play an important role in ensuring continued success by both funding a succession plan and reducing the risk represented by the loss of an owner or key employee. A key benefit of using life insurance is that it can be integrated with tools and strategies commonly used in succession planning, such as:
- Buy-sell agreements: Buy-Sell Agreements provide an orderly means of transferring a business interest upon the death, disability or retirement of an owner. However, buy-sell agreements must be fully funded to be useful.
- Key person insurance: Key Person Insurance is a simple, efficient way to provide your business with the liquidity needed to handle the loss of a key employee and recruit and train a replacement. The plan may also help to replace lost profits as a result of the loss.
- Estate equalization: Estate Equalization allows business owners to distribute assets fairly and equitably to each heir. In many closely held businesses, not all of the children will be suited to take ownership of the business. The life insurance proceeds will provide an inheritance to heirs equivalent to a portion of the business value, instead of a share in the actual business.
- Estate liquidity: Estate liquidity provides the business owner the ability to pay estate taxes due at his or her death without having to close or be liquidated. Life insurance provides an immediate source of income to the owner’s estate.
The tax-free growth of life insurance cash value is an attractive benefit to most companies and one reason why banks and corporations fund permanent insurance policies. Cash value accounts grow tax-free while within the policy.
Bank Owned Life Insurance (BOLI) is institutionally designed life insurance policies purchased by a bank or bank holding company. The policies generally insure the lives of bank executives or other highly compensated employees. The bank pays the premiums, owns the policies and is the beneficiary of death benefit proceeds. The bank accrues revenue from investment earnings and bears the risk of investment losses. Although the death benefit is of significant value in a BOLI purchase, the primary benefit of the life insurance structure is the available tax efficiencies on the growth of assets within the policies. Income earned on the policies is tax free for the bank, and when an employee dies, the cash payments the company receives are tax free. [See BOLI – Alive, Well and Growing.]
Cash flow management
Life insurance can improve the credit-worthiness of a business owner or the corporation itself. While the policy owner (an individual or a corporation) can always borrow against the cash value directly from the life insurance company, a policy’s cash value can be considered an asset when applying for bank loan preferred rates to finance capital expenditures. Additionally, the ability to borrow against cash value in lean times or when emergencies arise is a key feature of life insurance policies.
Finding and keeping the right employee is a key challenge in any business. An attractive benefit package can help a business secure and keep top talent. Life insurance can be used to fund employee benefits in various ways, thus helping business owners attract and retain high-quality employees.
Another benefit of using life insurance to fund business succession plans is the ability to use the proceeds as loan collateral. If business owners risk defaulting on a loan should a death, disability or retirement occur, a life insurance policy could be structured to use the benefit toward payment to the lender. In this case, the collateral assignment is signed by the owner of the policy and often by the lender, as assignee. If an unfortunate event occurs, the policy proceeds are used to reimburse the lender. Once the lender is paid in full, the beneficiaries under the life insurance policy receive the remaining proceeds.
Proper planning using life insurance as a financial tool can provide privately owned financial institutions and businesses with stability and protection, as well as operational advantages. Its most familiar role is as a key feature of a succession plan, offering liquidity upon the death, disability or retirement of an owner or vital employee. However, life insurance can play an even broader role in strategic planning, assisting with cash management and loan collateralization, offering tax-free growth, and recruiting top quality employees with benefit funding.