Life insurance for business owners
When we talk about life insurance, we typically focus on protecting families and dependents. A business is another insurable interest that can benefit from life insurance protection. Life insurance can help ease financial concerns for the family of business owners and help sustain the business through uncertain economic and strategic transitions. Whether it’s to cover a tax liability at death, to ensure adequate funding for a buy-sell agreement, or for use as collateral for a loan, a life insurance policy will often be purchased by a corporation to meet the business’s needs.
If you are a business owner then you are keenly aware of the importance of keeping your personal and business assets secure. However, life insurance may not immediately stand out to you as a part of your business protection plan. You might assume that a life insurance policy is for protecting your family or dependents should something happen to you, and that’s it.
But what would your business do if something unfortunate happens to you? Would your business continue if your dependents were responsible for settling or maintaining your business in your absence? If the business has any loans outstanding, how would those be settled in the absence of the business owner? If you would prefer to have your family receive a payout for your shares, who would purchase them, and can you do something to have the business pay for the shares?
Getting life insurance as a business owner is not only an effective way of protecting a business but it also comes with several other benefits such as settling business loans, buying back your shares in the business, covering the cost of a replacement for you, and settling any liabilities of the business if it closes. Life insurance can help protect those that depend on you and even act as collateral when taking out a loan to grow your business.
Do business owners need life insurance?
When it comes to an individually owned life insurance policy, a business owner’s needs are no different than anyone else’s. Like everyone else, you as a business owner, want coverage to take care of your loved ones or dependents financially after you pass away. You may have taken out loans or lines of credit to get your business started and your estate would need to settle these, should anything happen to you. This could eat into your family’s savings or force them to make a tough decision like selling your home to settle any business-related debts.
A life insurance policy can also help you access loans for your existing business. Banks and lending institutions consider a life insurance policy as part of their credit evaluation— having life insurance may even be a requirement to secure a loan. In some cases, an aspiring business owner can even access the cash value from a policy to secure the initial funding they need.
But life insurance isn’t just a consideration for small business owners and entrepreneurs. Those who own or manage large businesses also need to consider the protection that life insurance can provide the business should anything happen to their key employees or business partners. For these reasons, business owners of any stature need to consider using life insurance policies in their business protection plan.
How can business owners use personal life insurance?
An individually-owned personal life insurance policy is important for most business owners to settle their personal finances such as:
- Replacing the contribution you would have made to household income
- Personal debts like mortgage, car loans, credit card debt, or lines of credit
- Covering the costs of raising children or taking care of older dependents
- Children’s future education costs
- Augmenting retirement assets
- Creating an additional income source through those years
- Planning for end-of-life expenses
- Meeting legacy goals such as leaving assets for children and grandchildren
How can business owners use life insurance for business purposes?
Life insurance can also be used to settle business finances as well, depending on the business’ needs. Business owners can utilize business life insurance to provide:
- Key employee retention – to fund a deferred compensation plan and provide supplemental retirement income to an employee or offer a larger death benefit protection to employees to attract and retain talent
- Key person insurance – to fund the cost to replace a key person or meet revenue shortfalls or any other operational losses arising from the death of an important business partner or employee
- Funding a buy/sell agreement – to facilitate a smooth transition of the deceased owner’s interest in the business to the surviving owners or liquidity for the deceased owner’s family
- Estate equalization– to ensure that assets are transferred fairly between beneficiaries
- Debt and collateral coverage – providing cash to pay off business loans and debts. Providing cash to help weather uncertain economic cycles, meet overhead expenses or provide supplemental cash flow
Whether it is through term life insurance or a permanent life insurance policy, a budding or established business owner would be wise to calculate how much coverage they need to ensure their family, business, and employees were taken care of should they die unexpectedly. Check out our online life insurance calculator to see how much coverage you need.
Can a business own a life insurance policy?
Yes, a business can own a life insurance policy and stipulate themselves as the beneficiary if they have an insurable interest in the individual getting coverage. The policy protects the company’s financial interests. These policies are often referred to as COLI (company-owned life insurance) or in the case when financial institutions or banks own the policy, BOLI (bank-owned life insurance).
There are several advantages to owning a policy under a business such as utilizing the capital dividend account (CDA), protecting the policy against creditors, streamlined policy management, equitable sharing of premium payments, and reduction of the tax cost of the premium.
Are insurance premiums paid for by a corporation tax-deductible?
Whether or not your insurance premiums are tax-deductible depends on the company’s specific tax situation. In most cases, the premiums paid for by a company are not tax-deductible, but for some specific exceptions, they can still be financed by corporate dollars. In cases, where the policy is being used as collateral for a loan, premiums may be tax-deductible for the company. Premiums paid on behalf of employees, such as in the case of group life insurance, where the employees are the beneficiary of the policy, may also be tax-deductible. However, in such cases, premiums paid may become a taxable benefit to the employees.
Since corporate tax rates are usually lower than personal tax rates, paying for a whole life policy with after-tax corporate dollars is usually more efficient than using after-tax personal dollars. Many business owners, therefore, prefer to have their life insurance coverage be owned and paid for by the business.
How does corporate-owned life insurance work?
The corporation buys a permanent life insurance policy on an employee’s life to protect the value of the corporation. The corporation becomes the policy owner, pays the premiums, and is also the beneficiary of the policy. The premiums are paid monthly or annually from the corporation’s cash flow, or by transferring funds from investments the corporation owns.
Upon the passing away of the insured individual, the corporation makes a claim on the death benefits. Once the insurance proceeds are received, they are not taxable to the corporation. The company can notionally add the value of the proceeds (net of any adjusted cost basis) to the company’s capital dividend account, a notional account used. The capital dividend account is a notional account that can be used to pay out the life insurance proceeds tax-free to shareholders as a capital dividend. An amount equal to the capital dividend account can be paid out of the corporation at any time as desired by the beneficiary as a tax-free capital dividend. Any amount remaining can be paid as a taxable dividend.
What are the different types of life insurance for business owners?
There are two main types of insurance: term insurance (10,20, 30 years, etc), and permanent insurance (for your entire life).
Term life insurance is life insurance that lasts for a specific period of time known as a Term. The term can be a fixed number of years or until you reach a certain age (e.g. age 65). You pay premiums to the life insurance company until the expiry of the term. In return, your beneficiaries are entitled to receive a tax-free death benefit if you die within the term of the policy. Once the term ends, your coverage also expires, and you can stop paying premiums.
A term life insurance would be an ideal product to meet the needs of a small business that has short-term debts, such as mortgages or loans, and is looking for a policy with a lower premium.
Whole life insurance (sometimes called permanent life insurance) covers you for life and there is an investment or cash value component associated with your policy and its lump sum, tax-free payment. As you pay into your permanent insurance policy over time, it builds investment value.
Universal life insurance (UL) is a type of permanent life insurance that combines lifelong coverage with flexible payment options and an investment component. Universal life insurance offers a way to maintain coverage while also building wealth for your beneficiaries. It has the added benefit of allowing you to tailor the cost of your insurance premiums and investment options.
Term-to-100 insurance plans are a whole life insurance policy that doesn’t have a cash-out option, so it only pays upon your death (making it a little cheaper). It offers a bridge between term and whole life insurance. Plus, if you make it to 100 years, you are no longer required to pay premiums and still retain the coverage.
Permanent insurance is ideal for business owners who are looking to leverage life insurance’s cash value to benefit their business. Many permanent life insurance products have investment components and opportunities to actively manage those investments.
How much life insurance do business owners need?
Determining your life insurance needs will vary depending on your personal and business needs. The sweet spot for how much life insurance you need may not be obvious. You don’t want to choose a policy with so little death benefit that it won’t cover any outstanding debts as well as the cost of living for those you leave behind.
At the same time, choosing an amount that’s too large may prove costly for the premiums you pay while you are alive. What if you realize you may not have needed that much insurance coverage and could have saved some money?
A common rule of thumb is to choose 8-10 times your annual income as your death benefit.
For personal life insurance, take into account any debts you have, your family’s living expenses, future education needs of your children, plan for end-of-life expenses and any other allocations (for example, charitable donations) you may want to make.
For business life insurance, take stock of your business loans, inventory costs, costs to replace key employees, costs to buy you out of the partnership after death, etc. After tallying all your business needs, you may come to realize that setting up a business-owned life insurance policy can give you bonuses beyond that of a personal life insurance policy.
How do I get life insurance if I’m a business owner?
Getting a life insurance policy is the same whether you are a business owner or work in any other profession. An independent broker like PolicyAdvisor can help you sort through your options, find you a quote, and advise if your insurance needs are growing beyond that of a personal broker. We can also collaborate with tax lawyers to ensure that your business will be passed down in a tax-efficient manner. Reach out to our experienced advisors below and they can get you started down the right path for covering yourself and the business you’ve built.
The information provided herein is for general informational purposes only. It is not intended and should not be construed to constitute legal or financial advice.
- Business owners need life insurance the same as anyone else with dependents
- They also often need extra protection to compensate for loans, debts, or expenses they've incurred to get their business started
- Life insurance can be purchased in the business name to ensure that the business runs smoothly and without extreme tax implications after death