For small business owners, life insurance can provide many benefits, such as the typical motivating factor for any potential policyholder: providing enough money for the family if the primary breadwinner dies.
Just because you own a business doesn’t mean it’s worth a lot of money at any given time. Even if this is the case, this value is often not very liquid and can only be realized by selling the business. Therefore, the surviving family members would depend exclusively on the cash flow generated by the business.
Another important reason a business owner may purchase life insurance is to provide cash to pay inheritance tax upon the death of the policyholder. Inheritance tax is due in cash nine months after death. A family might be in a situation where they need to use most or all of the cash available, borrow from a bank, or sell a business quickly under duress. Life insurance is very frequently used to avoid these pressure situations.
To subscribe to Kiplinger’s personal finances
Be a smarter, more informed investor.
Save up to 74%
Sign up for Kiplinger’s free email newsletters
Enjoy and thrive with Kiplinger’s best expert advice on investing, taxes, retirement, personal finance and more – straight to your email.
Profit and thrive with the best expert advice from Kiplinger – straight to your email.
On a more personal level, when an entrepreneur has one or more children who work in the business and other children who do not work in the business, life insurance can be a very effective in promoting equity in succession. Leaving the business to the children who participate in it, while giving the other children the benefit of life insurance, benefits the family members, both financially and in terms of the relationships between them.
Joint ownership considerations for life insurance
Life insurance policies can also play a pivotal role in joint business ownership cases. There are generally two types of buy-sell contracts. One is a cross-purchase agreement, in which business owners get life insurance policies on top of each other.
This type of agreement is usually designed so that upon the death of one of the partners, the surviving owners can use the death benefits to purchase the deceased partner’s interest in the business from their estate.
The other type of buy-sell agreement is called an entity purchase agreement, in which the company itself holds insurance policies on the lives of co-owners. When one of the co-owners dies, the company receives the death benefit and can use it to buy the deceased owner’s stake in his estate, but these shares then become treasury shares.
Entity purchase agreements can be very useful when there are many partners in a business, so each partner does not need to have a life insurance policy on every other partner.
In a family, what is considered “fair” varies among family members.
Returning to the concept of family equity: although it is often favored by business owners who obtain life insurance, the implementation of a plan can vary widely. To begin, one must first define “right” in a particular situation. Fair does not always mean ‘equal’, and the policyholder must decide what they think is appropriate rather than leaving that decision to their beneficiaries – who are likely to have differing opinions on the matter.
Just is a concept that exists in the mind of the beholder, for both givers and recipients. The key is to make choices consistent with your goals. Remember that all of this is free money for the recipients. It’s a gift, not a right.
Individuals are not obligated to leave property to their children, so it is important to emphasize to recipients that everything they receive is provided out of love and generosity.
Communication within the family in advance is key
When clients seek our advice, our role is often to tell stories. Over the years of working in our respective fields, we have seen a multitude of situations play out in different family circumstances. We can offer helpful information based on these experiences, as well as provide education on different options and structures.
While every situation has its unique elements, one universal piece of advice we would give is the importance of communication within the family about your plan before death – particularly if the plan includes aspects that your children might consider favoring each other.
Ultimately, the decisions are yours and you have earned the right to make them. However, if you want your family to get along and spend time together after you’re gone, it’s important that they understand what you plan to do and why. This conversation could also provide insight that you hadn’t considered before, leading you to change the plan.
Life insurance is a versatile tool for providing cash to a family that might otherwise be mostly illiquid – as well as meeting general spending needs, covering property taxes and possibly helping to provide fair inheritances.
For business owners in particular, life insurance can provide a host of benefits both professionally and personally.
This article was written by and presents the views of our contributing advisor, not Kiplinger’s editorial staff. You can check advisor records with the SEC (opens in a new tab) or with FINRA (opens in a new tab).
#Life #Insurance #Strategies #Owning #Family #Business