Financial Checkup: What Type of Life Insurance Do I Need?
An Insurance Pro Shares Which Protections You Should Put in Place
When you’re experiencing the thrill of building a business, the last thing you want to think about is life insurance. However, unforeseen circumstances can derail the best of plans. Consider life insurance a strategic tool that can keep your company afloat in the event of a death.
Say a business partner passes away. “Do you really want to use all of your cash to buy out a partner when you can use life insurance, which costs pennies on the dollar, to do the same thing?” asks Ty Kashmiry, president of Ty Kashmiry Agency Inc. in Powell, Ohio.
As an entrepreneur, there are a number of ways to use life insurance to financially protect your business.
Here, Kashmiry explains your options.
Why is it important for small business owners to have life insurance?
Losing an owner or key employee could hurt the business depending on their skill set and responsibilities. Having a life insurance policy that protects the business in the event of a death can provide the company cash flow until a replacement is found.
If the business owner has a partner, a buy-sell agreement is often formed when they form the corporation, which means if one of the partners passes away, the other partner has the first right to purchase the shares. Life insurance can be used to purchase the stock of the other owner.
What types of life insurance should the small business owner consider?
There are two options. A term life policy is a simple, inexpensive policy designed to protect the business for a set period, such as: 10, 20, or 30 years. The second type is a permanent policy, which provides insurance protection for as long as you live and combines a death benefit with a savings portion. You can build cash value and borrow against it to help meet future goals such as buying property.
With a permanent policy, are you borrowing against what you’ve already put in?
Yes. Let’s says there’s $10,000 of cash value and you borrowed $5,000. If something were to happen to you before the loan amount + interest was paid back, and the policy was worth $300,000, then the business would get $295,000 – any outstanding interest.
Are there any other business protection arrangements an owner can set up using life insurance?
If you don’t have what we call a key man policy, consider getting one. For instance, let’s say you’re a sole proprietor and have five different restaurants, but you have a district manager and that district manager is able to manage all five stores. What I advise is making sure you have someone who is that key for you and getting a life insurance policy on that person. Usually, it’s a term policy. This allows you to have some cash flow in the event of the key person’s death and it gives you time to hire a new employee.
Who benefits from having life insurance to protect the business?
Usually, the business is both the policy owner and the beneficiary. Making an heir the beneficiary is problematic because the heir will likely already own stock in the business and get any personal life insurance benefit, so there would really be no benefit to the business.
What’s the decision-making process when buying life insurance?
Working with a good agent and a reputable company is key. Also, talk to your accountant and attorney to make sure there’s a buy-sell agreement in force to protect you if a co-owner dies or wants to leave the company. In addition, see that your accountant has evaluated the business properly in order to ensure the right amount of protection. Then, apply for life insurance on the co-owners to provide the cash needed to buy out the others’ stake if they were to pass away.
How do you determine how much insurance you need?
We usually ask owners to get advice from their accountant. Sometimes, small businesses will go with their gross sales to determine how much insurance is needed. Once we receive that number, we like to pad it by about 150 percent of the value of the business so that the owner is not buying life insurance every two years.
How much should small business owners expect to pay in premiums?
The cost of each policy varies according to the death benefit, time period, age, and health of the consumer, but, generally speaking, the premium could be as low as $40 a month or as high as several hundred dollars per month for a term policy and could be much higher for a permanent policy.
How does an owner ensure they are getting the best policy for their money?
Get more than one quote from different carriers and double check to verify that the carriers are ranked A+ with A.M. Best, a widely recognized provider of ratings for the insurance industry.
Educating yourself about your options when it comes to life insurance is key. “A lot of agents don’t talk to business owners about life insurance for their business,” Kashmiry says. “Talk to other business owners to see if they know someone who specializes in this area.”