Protect Your Business: How Insurance Delivers Security and Opportunity
If you’re a business owner, insurance can help provide not only protection, but opportunity when it comes to growing your business. Life insurance policies can help protect shareholders and their family members, the corporation itself, as well as key persons to the business. It can also help enhance cash flow to the corporation by assigning the policy as collateral for a loan. Let’s take a closer look.
Shareholders’ Agreement
A shareholders’ agreement is one of the most important documents for a business to have because it addresses several important aspects relating to share ownership, such as:
Issues relating to who can own/buy/sell shares
What happens upon the death/disability or bankruptcy of a shareholder
Typically contains right of first refusal and methods of dealing with offers from third parties
Other issues such as dividend policy, employment terms, non-competition, etc.
In corporations with multiple shareholders, a well-crafted agreement will allow for a smooth transition after the death of a shareholder. Even very successful businesses oftentimes do not have the funds available to buy out a significant shareholder, and without that funding, the spouse or child of the deceased could become partner even if that is not a desirable outcome for all parties involved.
Insurance on the lives of shareholders means there will be immediate funding available to purchase their shares in the event of death or a disability. Insurance can be more cost effective and convenient to fund a buy/sell than other options such as using borrowed money, liquidating assets, creating cash reserves or using after-tax corporate profits. At the same time, the shareholder can utilize the tax efficient nature of life insurance to achieve their estate planning goals.
Keep in mind that it’s crucial to periodically review the value of the corporation to ensure that the buy/sell is properly insured and that the amount of coverage continues to increase in step with the business.
A NOTE ABOUT TAXES: The life insurance benefit is received tax free by the corporation on the death of the shareholder and generates a credit to the Capital Dividend Account (CDA). The CDA can in turn be paid tax free to the estate of the shareholder. The CDA is a valuable tool that can be used in post-mortem planning to remove potential double tax on the death of a shareholder.
Other Uses of Corporate-Owned Insurance
Key Person Insurance – This coverage is common with small to medium sized businesses where there are one or more key people whose death, disability or critical illness would significantly hurt the organization. Often, people think of a key person as only a shareholder; however, a key person can also be a hired executive or anyone whose death, disability or departure will harm the financial health of the business. The most common formula in determining coverage is 5 to 10 times the compensation that the person earns.
Collateral – It is quite common that lenders (banks or other financial institutions that lend funds to small businesses) will ask the borrower to provide life insurance on the lives of the key shareholders or employees as a condition of lending. Having the right insurance in place will help your position if this need should arise. The loan interest may be deductible, subject to certain conditions, which is also financially advantageous.
Charitable Giving – Just as insurance can be an effective tool for individuals to donate to charity, corporate insurance can likewise be used tax effectively this way. Either new or existing corporate insurance policies may be used to benefit a charity in different ways such as:
Policy ownership assigned to the charity
Corporate owned policy used to fund an estate gift
Corporate owned policy used to fund corporate gifting
Estate Protection – Insurance can provide a very tax efficient way to help enhance or create an estate. It can be used to pay taxes due upon death, thereby protecting the value of the estate for the beneficiaries.
Estate Equalization – It’s common in family-owned businesses that not all the children want or are suited to work within the business. Yes, the parents want to see the child that continues to run the business inherit it, but they also want to see their other children dealt with fairly. A solution that can help is life insurance; delivering liquidity when it is needed most.
Your life, your family and your business deserve protection. Insurance can not only help provide that protection but can also help you build assets in a tax effective way for your retirement or estate plan.
For more information on how to safeguard your business, read How Corporate Insurance Can Benefit Your Business and When Your Business Owns a Life Insurance Policy, Proper Set-Up is Key and watch SMART TALK… how insurance can help build your business.