How to Choose a Life Insurance Policy as a Business Owner
A personal life insurance policy protects the wealth of your loved ones, but business life insurance has a broader mandate, which is to help your business continue should you die. In addition, life insurance is required for SBA-underwritten loans.
Life insurance for Business Owners
Insurance for small business owners is ideally part of a succession plan that specifies who will fill your shoes when you’re gone. In fact, business life insurance is often coupled to a buy-sell arrangement in which a surviving partner or other individual uses the proceeds from the insurance policy to buy out the heirs of the deceased’s portion of the business. This makes sense if a spouse or children who haven’t been involved with the business would inherit control of the company. The life insurance policy ensures that the family is financially protected while the buy-sell arrangement guards the viability of the business.
Insurance for Small Businesses
The major factors an owner should consider when choosing a business life insurance policy include:
- Type: Term life insurance is less expensive than permanent polices that build cash value. That’s because a term policy ends on a date certain (assuming the insured is still alive). However, renewing term life policies can be problematic, as their price shoots up sharply as you age, and there is no guarantee you’ll be insurable at renewal time. Term policies can make sense if you view the business as a short-term endeavor, one you expect to conclude on or before the policy’s termination date. However, if you consider the business to be perpetually ongoing, a permanent policy will cover your demise whenever it occurs, and will be less expensive in the long run.Some term policies can be converted into permanent ones if the situation warrants. Furthermore, the cash value of the policy can be used to pay premiums. In addition, it can be borrowed against to provide extra cash when needed. If the cash value is invested wisely, it might grow into a tidy sum. Permanent life insurance for a business run by a pair of partners can be used to provide a cash distribution if both partners retire at the same time and close or sell the company.
- Structure: A cross-purchase structure is one in which each partner is the beneficiary of a policy on the other. The surviving partners uses the death benefit to buy the deceased’s portion of the business. If there are more than a few partners, an entity-redemption plan makes sense. In this structure, the business is the beneficiary of multiple life insurance policies, and it receives the death benefit if a partner dies. The benefit is used to buy the deceased’s share.
- Amount: The proper amount of life insurance for business owners depends on the value of the company, the need to pay off heirs, the deceased’s level of engagement with the company, and other factors. The policy must pay enough to accomplish its goals, and might need to be augmented as those goals change. A successful company can easily outgrow the original death benefit, especially if coupled to a buy-sell arrangement. Business owners would do well to buy a policy that guarantees the owner’s right to increase the death benefit over time. A change in the status of the owner’s heirs, from events such as divorce or death, might also require adjustments to the policy.
- Key persons: Many companies use key person insurance to compensate for the loss of individuals who add substantial value to the business. It not only covers the death of a key person, but also any other reason for separation. For example, it might be hard to replace an executive in charge of a proprietary product or service, which means the key-person insurance needs to be of sufficient size to help offset the costs of replacement. An entity-redemption plan is appropriate if the business employs several key persons.
Buying the right policy is a very important event in the life of a business, and an expert should be brought in to structure the elements of a company’s succession plan, including insurance and buy-sell arrangements.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.