Types of Life Insurance for Business Owners
Updated: Oct 10
Collateral assignment for a loan
Funding a buy-sell agreement
Key man insurance
Collateral assignment for a loan One of the most common reasons life insurance brokers will often find themselves selling life insurance to small business owners is in order to secure a loan from the small business administration (SBA). The SBA usually requires a life insurance policy that is collaterally assigned to the bank providing the loan in order to secure against the untimely demise of the business owner. Once the life insurance policy is issued and paid for, the collateral assignment is filed giving the bank first access to any amount outstanding on the loan. Collaterally assigning the policy is different from appointing the bank as a beneficiary on the policy and benefits both the bank and the policy owner in a few ways. First and foremost, as the loan is repaid, there is no need to constantly update the beneficiary percentages. Rather, the only amount that would go to the bank at any time is the remaining unpaid balance of the loan. Additionally, the owner of a life insurance policy can, at any time, change the beneficiary on the policy, without the beneficiary's knowledge or consent, barring an instance of an irrevocable beneficiary. Were the bank to only be appointed as a beneficiary, the very next day, the policy owner could potentially completely cut the bank out of the policy by simply changing the beneficiary to a family member etc. By appointing the bank as a collateral assignee, the names, relationships or percentages of the beneficiaries are of no interest to the bank, as the beneficiaries only have rights to the remainder of the death benefit once the loan balance is paid to the bank. Another benefit for the bank is that if the owner of the policy were to fall behind on their payments, the assignee would be notified, in contrast to a beneficiary where no such notifications are provided.
Executive Benefits Business owners may purchase a whole life policy for themselves, or more often, their employees, as a benefit. The construction of the policy is flexible, however, a typical theme is that the premiums are paid by the business, and the cash values will vest in favor of the employee over a set number of years. This can incentivize the employee to stay with the company to reap the full benefits of the policy. In case of the employees untimely demise, the death benefit will be paid to the employees family, with a possible refund of the premiums going to the business if that option was chosen on a universal life policy. There are some tax implications for such policies as explained here.
Funding a Buy-Sell Agreement A buy-sell agreement is a legal arrangement in which partners and multiple business owners agree that if one of the owners is no longer able to perform their function due to death or disability, they will sell their share to the remaining owners. The logic behind such an agreement is to enable the business to continue without having new parties who may not have the businesses best interests in mind become shareholders in the company. The actual agreement does not require funding, rather upon the need to exercise the contract, the business can come up with the required cash. The issue is, usually this will be a significant amount of money, and to achieve such liquidity, the business can suffer devastating losses in a fire-sale, or be required to take on high interest loans etc. By funding a buy-sell agreement with a life insurance policy, the business partners are planning for a rainy day by covering this liability for a fraction of the cost.
Group Policies Group life insurance for small and large businesses allows the owners and employees to take advantage of group rates and acceptance unavailable in the private market. While purchasing a policy yourself may turn out to be more economical if you are young and healthy, once age and health issues creep up, obtaining a policy via a group may be with your while. Group policies will often be issued through accelerated, guaranteed or simplified underwriting methods, thus making health issues not as big of a problem.
Key Man Insurance Businesses, particularly small ones, often rely on a specific member of the team for their expertise, connections and general know-how. If this employee or owner were to pass, the business can suffer devastating losses. The need to find someone to replace and train this star would surely take time and cost a lot of money. The key man life insurance policy concept was designed to fill this need. The insured is the special employee or owner, while the beneficiary is the business. When this unfortunate situation occurs, the business can rest assured that at the very least, financially, it will persevere.
Retirement Planning Life insurance can be purchased and designed for its tax benefits and relied upon to supplement retirement. The policy can be within a qualified plan such as a 401k or unqualified. This is a strategy often used by business owners to set up a pension like fund for themselves while also having a death benefit in case the need arises.
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