Protecting the Business You've Built

A small business is often a family's biggest asset and its main source of income. If an owner or key person died or became seriously ill, the business could struggle, and so could the families who depend on it. Here are the basic ways life insurance can help.

Key person coverage

Most small businesses have a few people who are hard to replace: the owner, a top salesperson, a skilled specialist. With key person coverage, the business owns a life insurance policy on that person, pays the premiums, and is the beneficiary.

If that person passes away, the money goes to the business. It can help replace lost revenue, pay to recruit and train someone new, cover loan payments, and give customers, lenders, and employees confidence that the business will keep going.

How much coverage? Businesses often estimate based on the person's share of profits, the cost to recruit and train a replacement, and any loans or contracts that could be at risk without them.

Funding a buy-sell agreement

If you have business partners, ask yourselves a hard question: What happens to an owner's share if they die? Without a plan, a partner's spouse or children could inherit part of the business, even if they don't want to run it. The remaining owners may not have the cash to buy them out.

A buy-sell agreement is a legal contract, drafted by an attorney, that spells out who buys an owner's share and at what price. Life insurance is a common way to fund it, so the cash is there when it's needed:

Cross-purchase: Each owner owns a policy on the other owners.
Entity purchase: The business owns a policy on each owner and buys back the share.

Each setup has different tax and ownership effects, so your attorney and CPA should help you choose. Update the agreement and the coverage as the business grows in value.

Consult an attorney or CPA.

Protecting the owner's income and family

Business owners often don't have the workplace benefits employees get, such as group life insurance. Many have also personally signed for business loans or leases, which could become a burden on their family.

Personal life insurance, with living benefits where available, can help protect the owner's household. Some businesses also offer life insurance as an added benefit for owners or key employees, such as through an executive bonus arrangement, where the business pays the premium as a bonus. Tax treatment varies, so talk with your CPA first.

Getting the details right

Employer-owned coverage has rules. Under federal tax law, a business generally must give an employee written notice and get their written consent before buying a policy on them, to keep the death benefit's favorable tax treatment. There are also yearly IRS reporting requirements.
Value the business realistically. Coverage should match what a share is actually worth.
Review regularly. Revisit your coverage when you add partners, take on debt, or your business value changes.

Consult an attorney or CPA.

Questions people ask

Do sole proprietors need business protection?
It depends. If the business has debts, employees, or a family relying on its income, personal life insurance and a plan for what happens to the business are worth discussing.

Are key person premiums tax-deductible?
Generally, no, when the business is the beneficiary. The death benefit is generally received without income tax if federal rules are met. Your CPA can confirm for your situation.

Who should own the policy in a buy-sell plan?
It depends on the type of agreement, the number of owners, and tax considerations. Your attorney and CPA should help decide before any policy is applied for.

Source: IRS, employer-owned life insurance rules (Internal Revenue Code section 101(j); Form 8925).

WEDOIT education, led by Dr. Joel M Tchafack, PharmD, licensed life insurance professional in NM, CO, MD, NC, SC, TN, TX, VA and WY (NPN 19623090). WEDOIT LLC, Carlsbad, New Mexico. 575-266-3119. info@wedoitinsurance.com

This content is for education only and isn't tax, legal, or investment advice. Coverage and benefits depend on the product, carrier, state, and underwriting.