Life insurance plays a powerful role in protecting businesses of all sizes — whether you’re a sole proprietor, a partner in a small firm, or the owner of a growing company. This page covers the three most important ways business owners use life insurance: Key Man (Key Person) coverage, Buy-Sell Agreements, and Executive Bonus Plans.
Key Man Life Insurance (Key Person Life Insurance)
What is Key Man Life Insurance?
Most companies employ at least one person who represents the key to the success of the business — often the owner of the company. The loss or death of that person could deal a real blow to the company and its ability to generate revenues to survive. Someone else must be hired to carry on the same tasks, and that expense, in addition to the loss of revenue, must be reconciled.
Many owners therefore insist on buying life insurance to minimize the risk, and many lenders require that the business carry key person life insurance to protect their loans and investments into the company.
How does Key Man Life Insurance work?
The key person must agree to the purchase of insurance on his or her life. The business typically owns the policy, pays the premiums, and remains the beneficiary. The policy can be transferred to the employee if he or she leaves the company, or can be retained if the company is sold — the new purchasers may want to keep the insurance in recognition of outstanding loans that may be secured to buy the interests of the insured.
Are there other reasons to have Key Man Life Insurance?
Key person life insurance policies are often used to support a buy-sell agreement between business partners (see below). The proceeds can be structured to purchase the deceased person’s shares or interests in the company. The agreement mandates that the deceased executive’s estate sell its stock to the remaining partners/shareholders, and that the partners/shareholders purchase the interest for a specified price. The price should help establish the value of the business for estate planning purposes and calculating the estate tax upon death.
Buy-Sell Agreement Life Insurance
What is a Buy-Sell Agreement and why does my business need one?
A business owner wants to ensure a smooth transition and protect the family’s interests in the event of death. While there are many strategies available, a buy-sell agreement among partners, shareholders, and/or employees can help accomplish this goal.
The buy-sell agreement is a contract that obligates, upon the death of an owner, that the deceased executive’s estate sell — and the remaining partners/shareholders purchase — the business interest of the company at a specified price. The heirs don’t have to worry about running the business, they receive a fair price for the sale, and they avoid many of the delays associated with probate. The surviving owners don’t have to worry about interference from possibly unwanted partners (heirs), they know the purchase price beforehand, and they remain in good standing with clients and lenders.
How can I fund a Buy-Sell Agreement?
There are a few options:
Wait and Pay Cash. At death, there may not be enough cash available to fulfill the agreement. You may have to liquidate assets that can’t be readily sold (e.g., real estate). You also lose the investment value of the assets that you do liquidate. This option uses 100% of your own after-tax money.
Wait and Borrow Funds. By securing additional loans, you may stymie future growth by increasing expenses. Lenders may balk at other loans needed to expand the business. Remaining partners/shareholders may have to sign personally to secure the loans, thereby exposing personal assets to creditors. This option uses 100% of your own money plus additional interest.
Purchase Life Insurance. Proceeds are immediately available upon death, income tax free. Premiums could be less than just the interest required on a loan. This option uses 100% of somebody else’s money — the insurance company — for pennies on the dollar.
How are Buy-Sell Agreements structured?
While other funding arrangements can be structured, two options remain the most popular:
Cross Purchase Agreement. The owners purchase a policy on each other and pay the premiums themselves. The proceeds are paid to the surviving individual(s), who then buys the interest according to the agreement. This arrangement works well when the owners/partners/shareholders are approximately the same age and in similar health. A major advantage lies in the increased cost basis for the business interest acquired — when the business is subsequently sold, there are far fewer taxes to be paid.
Entity Plan. The business purchases the policy on each of the owners, pays the premiums, and receives the proceeds upon death. The proceeds are used to purchase the business interest from the heirs, and the remaining partners/shareholders own the company in its entirety.
Executive Bonus Plans (Section 162)
What is an Executive Bonus Plan?
An Executive Bonus Plan, as permitted by Section 162 of the Internal Revenue Code, is an arrangement to provide supplemental income and/or death benefits for select key employees of a company. The plan is funded with a permanent life insurance policy — either universal life or whole life — featuring cash values that is purchased for the selected employee.
The arrangement permits the employee to own the life insurance policy and designate their desired beneficiary. The company pays the premium directly to the insurance carrier, and the premium is treated as a bonus to the employee. The cost to the employee is the tax on the bonus (rather than the full premium), while the premium paid to the carrier is deductible to the employer.
Benefits for the Employer
- No IRS restrictions or prior approvals required
- No Government forms or reports to file
- No burdensome administrative processes
- No mandatory eligibility or participation rules
- No required plan provisions
- Employer selects which employees participate
- Program can be custom-tailored for each participant
Benefits for the Employee
- Permanent life insurance benefit providing income-tax-free proceeds to surviving family at death
- Cash values grow on a tax-deferred basis to provide additional income at retirement
- Employee owns the policy and names their own beneficiary
Other Group Benefits for Employers
Life insurance is just one piece of a comprehensive employee benefits package. If you’re a business owner looking to attract and retain top talent, you may also want to explore:
- Group Health Insurance — Offer your employees access to medical coverage through fully-insured, level-funded, HMO, PPO, HDHP, and other plan types. We’ll help you find a plan that balances quality coverage with manageable costs for your business.
- Group Disability Insurance — Protect your employees’ income with employer-sponsored short-term and long-term disability coverage. Group disability is one of the most valued benefits you can provide, and we can help you design a plan that fits your workforce and budget.
To discuss any of these business life insurance strategies or to get a free quote, give us a call at 1-888-972-0024, get an instant quote online, or send us an e-mail anytime.