Life Insurance for Business Owners

The list of people of counting on you grows as you build a business: your family, business partners and employees.

Life insurance provides a financial safety net for all of them in the event of your death, removing some of the worry so you can focus on day-to-day issues. The key is getting the right coverage in place.

“It’s an essential conversation to have and a topic that must be addressed,” says Michael Weisman, a financial planner and president of the Wealth Products Group for Enterprise Trust in St. Louis.

When buying life insurance, consider what you want the coverage to accomplish to determine the right type and amount.

Here are the main functions of life insurance for business owners:

It can replace your income

If anyone depends on your income, then you need life insurance, whether you work for someone else or run your own business. If you die prematurely, your family can use the life insurance proceeds for everything from household expenses to funding the kids’ college education.

Type of policy to buy: Term life insurance, which covers you for a certain number of years, is sufficient for most people. Choose a term long enough to cover the years your spouse and children will depend on you financially.

Life insurance quotes are available through NerdWallet’s life insurance comparison tool.

It can cover your personal and business debts

You might have secured a business loan with personal assets, such as your home. In that case, you need life insurance to cover that debt and protect those assets for your loved ones.

Don’t assume your family will be able to liquidate the business to pay off lenders. If forced to sell the business quickly, your heirs might have to unload it at a discount, or the business might not be worth much without you at the helm.

The lender could require you to buy life insurance as a condition of the loan, Weisman says.

But don’t name the bank as the beneficiary. Instead, request a “collateral assignment” from the life insurance company after the loan is approved, Weisman suggests. Under a collateral assignment, the insurer will use the life insurance proceeds to pay off the loan and give the remainder to your policy’s beneficiary, such as your spouse.

Type of policy to buy: Choose a term life insurance policy that matches the length and amount of the loan. You can buy a single term life policy to replace income and cover debts. Or you can purchase more than one term life policy of different lengths and amounts, such as a 30-year policy to replace income and a 15-year policy to cover a 15-year loan.

Helps heirs pay estate taxes

Even if you’re cash-poor, your business assets could be enough to put you over the federal estate tax limit, which is $5.43 million for a single person or $10.86 million for a married couple in 2015. But your state’s estate tax threshold could be much lower; for example, in New Jersey, it’s $675,000. A looming tax bill could force your heirs to sell the business in a hurry.

Nathan Mahlik, a State Farm insurance agent in Danville, California, says he saw that scenario play out in farming communities in the Midwest, where he used to live. When a family had to sell off land to pay estate taxes, others in the area knew they were desperate to sell and made lowball offers.

Life insurance proceeds can help your heirs pay the estate taxes. They can keep the business intact or take their time in selling it to get a decent price.

Type of policy to buy: For estate tax planning, you need permanent life insurance, such as whole or universal life, which provides lifelong coverage. A term life policy isn’t appropriate because it could expire before you die, and your heirs would be left with the tax bill — and no insurance to cover it — when you do pass away.

A permanent life insurance option called a “second-to-die” policy can be a good choice for couples, Mahlik says. This type of insurance pays out when the second person on the policy dies. The policy works because husbands and wives don’t owe estate taxes on property inherited from each other. Estate taxes become an issue for the next heirs, such as a couple’s adult children.

It can help you equalize your inheritance involving the business

Life insurance helps business owners treat their adult children fairly when not all of them are part of a business.

Suppose your daughter helps you run the business, but your son has nothing to do with it. Say you plan to leave the business to your daughter, and you want to leave an inheritance of equal value to your son. A life insurance policy can help you do that.

Type of policy to buy: In this case you’ll need permanent life insurance, which will ensure your heir gets the payout no matter when you die.

It can help fund a buy-sell agreement

A buy-sell agreement is a legally binding contract between business co-owners. The agreement spells out what happens to the ownership interests of a business partner who dies, becomes disabled or leaves the business. Life insurance for business owners is a simple way to provide money for a buyout if one of the partners dies.

Here’s how it works: The owners or the business purchase policies insuring each partner. If one dies, the life insurance proceeds are used to buy out that person’s share of the business. A funded buy-sell agreement helps avoid disputes and turmoil. Imagine if your partner died tomorrow. Without a buy-sell agreement and a way to fund it, you could end up in business with your partner’s spouse or kids.

Type of policy to buy: It depends. Most new business owners who don’t have a lot of cash flow choose term life, Mahlik says. A term life policy would also be wise if you plan to sell the business in a relatively short period, such as 10 years.

A permanent life insurance policy might be the way to go if you can afford it and you’re in the business for the long haul, such as 20 years or more.

It can protect the business against the death of a key person

Imagine if you or a hard-to-replace employee suddenly died. No matter how determined the remaining employees were to keep things going, the business would probably lose revenue while everyone scrambled to regroup.

Life insurance can provide “some working capital to get them through,” Weisman says.

Mahlik recently worked with a small construction business that bought life insurance on its crane operator. If the crane operator dies, the business can use the life insurance money to offset lost revenue while it recruits and trains a replacement for this hard-to-fill position.

Type of policy to buy: Term life insurance is an inexpensive way to protect against the loss of a key employee.

It can help you retain talent

You can use permanent life insurance to provide additional compensation to key employees, enticing them to stick around.

Typically a business will buy a permanent life insurance for the key employee. Although the business pays the premiums, the employee owns the policy and later can use the cash value to supplement retirement income.

In a “split-dollar” life insurance arrangement, the business and the employee share the costs, death benefit and cash value of the policy.

Type of policy to buy: Permanent life insurance is used in this type of compensation strategy.

Ways life insurance helps business owners & types to buy

Function	Term life	Permanent life
Protects your family by replacing your income	X
Covers personal and business debts	X
Money for heirs to pay estate taxes		X
Equalizes an inheritance if not all children get the business		X
Funds a buy-sell agreement	X	X
Provides working capital if a key employee dies	X
Provides a perk for valuable employees		X

Life insurance for business owners fills a variety of needs. Talk to a financial advisor or work with an insurance agent who has experience helping businesses like yours.

If term life insurance fits the bill, NerdWallet’s life insurance comparison tool can help you compare rates.

Barbara Marquand is a staff writer at NerdWallet, a personal finance website. Email: bmarquand@nerdwallet.com. Twitter: @barbaramarquand.

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