Here’s a look into how life insurance can protect your business.
Life insurance not only helps take care of your family, but can also protect your business if something happens to you, a fellow owner, or even a key employee. If you are thinking about buying life insurance—or if you think you don’t need it—here are a few things you should consider.
Q: How does life insurance protect a business?
A: There are two critical ways that a life insurance policy can be structured to protect your business in the event of death or disability of a co-owner or key employee.
One is a buy-sell agreement, which ensures that, if a co-owner dies, the remaining business owners will have the funds to buy the portion held by the deceased co-owner—at a previously agreed upon price. The buy-out money goes directly to that person’s family, or whoever inherited the business shares.
To protect the business from death of a key employee (typically defined as an employee who has a major ownership and/or decision-making role in the business), there is “key person insurance,” which is payable to the company and provides the owners with some financial freedom to contemplate their options.
“Having the foresight to protect your business against the loss of a key employee—a company's most valuable asset in some instances—can mean the difference between business as usual and closing up shop,” says Judith E. O'Brien, financial advisor at Capital Financial Partners LLC in Glen Allen, Va.
RELATED: Key Person Insurance: How It Works
Q: What’s the difference between term vs. permanent insurance?
A: Term insurance allows you to choose how much money your beneficiaries (whether your family or the company) will be paid upon your death, and how long you want the coverage to be in place. For example, you could choose a $500,000 policy for a 10-year term. This type of insurance often makes sense when you only need coverage until your building mortgage is paid off, or to give employees the time to replace you, for instance. Permanent insurance, on the other hand, provides lifelong protection and the full amount will be paid upon your death, as long as you’ve kept up with the premiums. It also has an investment component, as savings build within the policy and you can borrow against the cash value.
“Permanent life insurance is a great tool to generate a tax-free retirement plan, too,” says Ed Kinsey, a financial specialist with Prosper SBS, a full-service benefits company in Salt Lake City. In addition to your own policy, Kinsey advises offering permanent life insurance to employees. “It can be owned by the business and have a vesting period, which allows business owners to retain important employees.”
Q: Who should be covered under the policy and for how much?
A: When deciding who should be covered and for how much, O’Brien advises to ask yourself a few questions:
• What value does the key person bring to the team—creativity, sales acumen, leadership—and what is it worth to the business?
• How much revenue could be lost before you can find a replacement?
• How much will it cost to recruit and train a replacement?
• Will clients lose confidence in the company?
“With the help of a trained professional, you can estimate the financial impact on the business of these and other factors, and put in place effective life and disability insurance policies,” O’Brien says. “No one wants to imagine the worst. But making a plan for your business to survive is always a good decision.”
RELATED: Should I Offer Disability Insurance for My Employees?