Client Solutions: Business Life Insurance Information
Wortham's professional staff can quickly put together a life insurance program that can fund a wide range of business needs in the event of your death. Options include:
Key Person Life Insurance
The success of every company centers on "key" employees – and losing these workers would result in a material loss for the company. In addition to an immediate impact on profits, a company losing a key employee would incur the expense finding, hiring and training a replacement. Just as fire insurance protects against the loss of inventory or equipment, “key person” life insurance protects against the loss of human life value.
What is Key Person Life Insurance?
Key person life insurance is similar to standard life insurance because it can offset economic loss due to an individual's death. The important distinction is that this insurance can indemnify a company or a business in the event of a death. Key person life insurance is purchased by a business on the life of an owner or employee whose services contribute substantially to the success of the business. The company is both the owner and the beneficiary of this type of insurance.
What Are The Benefits?
Key person life insurance can assure that:
- The business can continue operations,
- Customers will understand that the operations will not be interrupted,
- Employees will know that their jobs are secure,
- Creditors will know that loan obligations will continue to be met,
- Established lines of credit with lenders and suppliers will not be affected,
- Cash value of the policy can be used as collateral or to help maintain credit ratings,
- Funds will be available to identify, recruit, hire and train a replacement,
- Funds can be accessed to offset any lost sales or profits, and
- Cash values can eventually be used to fund retirement benefits for the key employee.
Buy- Sell Agreements
These types of agreements can be a useful tool to achieve desired objectives among owners of a business (whether the business is conducted in the form of a partnership, limited liability company (LLC), or corporation). A Buy-Sell Agreement can confirm the eventual disposition of each owner's interests, or identify how ownership and control of a corporation will be handled in the event of a death of one of the owners.
Buy-sell agreements are normally funded by life insurance on the lives of the owners. These agreements can be used to restrict attempted dispositions of stock by stockholders during their lifetime (by sale or gift), in addition to restricting those who inherit from a deceased stockholder. Buy-sell agreements can effectively ensure the retention or transfer of control among stockholders during their lives and at their deaths. Buy-Sell funded agreements take the form of a corporate redemption agreement or a cross-purchase agreement among the owners.
Typical Buy-Sell Agreements
Cross Purchase Agreements typically require a stockholder who wants to "sell out" during his lifetime to first offer to sell his shares to the other stockholders. In the event they decline to buy, only then can the stockholder sell his interest to outsiders. If a stockholder dies (or in the event of another specified occurrence), the typical agreement requires the shareholder or their estate to sell (and the surviving stockholders to buy) their shares.
Stock Redemption Agreements typically obligate the corporation to buy (and the shareholder to sell) their shares at the price or under the formula specified in the agreement upon the occurrence of certain specified events. Alternatively, or in addition, such an agreement may include a right of first refusal procedure that requires a stockholder who wants to "sell out" during his lifetime to first offer to sell their shares to the corporation at a price or under a formula which is specified in the agreement. Only if the corporation turns down the offer can the stockholder then sell to outsiders. In considering a stock redemption agreement, note that the document must also conform to any local law governing redemption of stock. These different types of agreements may have different tax and economic effects – and Wortham professionals can guide you through the possible effects of these provisions.
Using Life Insurance to Fund the Future Cost of Buying Shares of a Stockholder
Stock redemption and cross purchase types of buy-sell agreements may be funded with insurance on the life of the stockholder, thereby assuring the availability of funds for the required purchase of a stockholder's shares. Under a stock redemption agreement, the life insurance on a stockholder is bought and paid for by the corporation, and is made payable to the corporation. Under cross purchase agreements, each stockholder buys, pays for and is the beneficiary of insurance on the lives of the other stockholders. (Thus, each shareholder must purchase a policy on every other shareholder.) Alternatively, under the cross purchase agreement option, it is possible to structure a cross-purchase plan that would require only one policy per insured owner by utilizing an escrowed ("trusteed") buy-sell plan. However, the plan must be properly implemented to avoid the transfer-for-value tax challenges that typically attend a trusteed buy-sell agreement.
Benefits of Buy-Sell Planning
While buy-sell agreements can provide an effective means of keeping and ultimately transferring ownership and control of a family corporation within the family, these agreements can serve other important planning goals. Buy-sell agreements also can assure:
- A market exists for the sale of the corporation's shares if the shareholder retires, becomes disabled or dies,
- A market for the sale of the corporation's shares will exist if an employee/shareholder ceases to be employed,
- That shares cannot be transferred to shareholders who are not compatible with the present shareholders,
- Preservation of S corporation status by preventing ineligible shareholders from buying shares of the corporation,
- Preservation of S corporation status by preventing ownership by more than 75 shareholders,
- Preservation of S corporation status by complying with one-class-of-stock requirements,
- Establishment of the value of the corporation's shares in some instances,
- That shares can be considered a part of estate or gift tax planning,
- That persons who are no longer active in the business will not continue as shareholders.
Other Forms of Business Life Insurance
- Split Dollar Life Insurance is a technique for "splitting" the cost and benefits of a life insurance contract. Simply stated, it is a method for sharing the premium, death benefit and cash value between two parties, usually the employer and the employee.
- Executive Bonus Life Insurance is a policy designed to provide individual life insurance to selected key employees. The premium dollars are deductible to the business as compensation and reportable by the employee as income. As the owner of the contract, the employee can name the beneficiary, make loans, take withdrawals, etc.
- Loan Repayment Life Insurance can assure the repayment of outstanding loans should the owner of the business die.