Guide to Buying Life Insurance for Business Owners and Entrepreneurs
Beyond safeguarding families, life insurance can be used as a business financial asset to ensure business continuity during transitions, fund buy-sell agreements and serve as collateral for loans.
Life insurance serves dual purposes for business owners. A personal life insurance policy offers a financial safety net for loved ones, while a separate business-focused policy can help ensure the company's stability and future. When buying life insurance for a family or business, you have to consider factors such as policy type, coverage and cost to make informed decisions.
Let’s learn more about how life insurance works for business owners to protect either the family or business.
Why Business Owners Should Consider Life Insurance
Business owners have personal and professional financial responsibilities. Buying separate life insurance policies for personal and business reasons can help safeguard both interests.
For Personal Reasons
A personal life insurance policy focuses on safeguarding the financial well-being of the policyholder's family.
Financial Protection for Family
A personal life insurance policy can ensure the family remains financially secure in the event of the business owner’s untimely demise. It can cover daily living expenses, children's education, mortgage payments and other outstanding personal debts. It ensures the family won't face financial hardships and can maintain their quality of life.
In family-run businesses where only certain members might inherit the company, life insurance can provide a payout to others to ensure fairness among heirs. It can also assist in reducing potential estate taxes.
For Business Reasons
When tailored for business, life insurance aims to secure the company’s continuity, stability and financial health during transitions or unforeseen events.
Businesses, especially smaller enterprises, can be vulnerable to the sudden loss of a high-ranking official. Life insurance acts as a safety net that can help ensure continuous operations in the face of such challenges. It provides the necessary funds to cover unexpected expenses, recruit replacements or stabilize the business during transitional periods.
Funding Partnership Agreements and Buyouts
Businesses with multiple partners often involve a buy-sell agreement — a legally binding contract stipulating how a partner's share is managed if they exit the business due to death, disability or other reasons. Life insurance can facilitate the execution of these agreements. For instance, the death benefit can be used to purchase the deceased partner's share.
The growth in cash values in certain policies is usually tax-deferred, meaning taxes are only due upon withdrawal. Moreover, death benefits are typically exempt from income tax, ensuring beneficiaries receive the full amount for business continuity.
Life Insurance as a Business Asset
Life insurance policies with cash value can act as savings or investments. As this value increases, it can fund business needs or be used as loan collateral.
Types of Life Insurance for Business Owners
Different insurance products are available to address your unique insurance needs as a business owner. You can pick between term and permanent life insurance for your policy type. You can tailor both types of life insurance to your desired purpose – personal life insurance, business life insurance for key employees, or buy-sell agreements.
This provides coverage for a specific period or "term" (e.g., 10, 20 or 30 years). If the policyholder passes away within this term, the death benefit is paid out to the beneficiaries. No benefit is paid if the term expires and the policyholder is still alive.
Cost-effective, straightforward and offers coverage for a specified term.
No cash value accumulation, and coverage ends after the term expires.
Offers lifelong coverage as long as you pay premiums. It combines a death benefit with a savings or investment component, allowing the policy to accumulate cash value over time.
Lifelong coverage, potential for cash value accumulation and can be used as a financial asset.
Higher premiums compared to term insurance.
Depending on your goal and situation, you can choose term or whole life insurance for a personal or business life insurance policy.
Personal Life Insurance Policy
A personal life insurance policy designed to protect your family’s financial well-being can be used for, but not limited to:
- Income Replacement: Compensate for the loss of the policyholder's income, ensuring the family maintains their living standards.
- Debt Settlement: Covers outstanding debts such as mortgages, car loans or credit card bills.
- Education Funds: Allow children to pursue their academic goals without financial hindrances.
- Funeral and Burial Expenses: Alleviate the financial burden on grieving family members.
- Estate Settlement: Assist in settling potential estate taxes and ensure heirs receive their rightful inheritance without tax liabilities.
If you want coverage for your children's education until they graduate, a term life insurance policy is suitable. A permanent life insurance policy is more appropriate if you want to leave a legacy or have long-term dependents, such as a child with special needs.
Business Life Insurance Policy
In a business life insurance policy, the beneficiary can be your company or your business partner. This insurance type is typically used to insure a key employee or fund partnership agreements.
Key Person Life Insurance
Key person insurance protects businesses from financial strains following the unexpected loss of a vital team member. While personal life insurance focuses on safeguarding the policyholder's family, the beneficiary in key person insurance is the business; this ensures immediate funds for business-centric challenges. You can use this insurance death benefit to offset lost revenue, assist in finding a replacement or stabilize the business during transitions.
Term life insurance offers cost-effective coverage tailored to a key employee's projected tenure, especially for non-owners. Business owners or partners often prefer permanent life insurance as it builds cash value, which businesses can borrow against or use as a retirement benefit.
Buy-Sell Agreements With Life Insurance
Buy-sell agreements with life insurance ensure the smooth transition of business ownership in scenarios involving the unexpected departure of a business partner. Here are its two types:
- Cross-purchase Agreements: In this setup, each business partner buys life insurance on the other partners. If one partner passes away, the surviving partners use the death benefit to buy out the deceased's share.
- Entity Purchase Plans: Here, the business purchases life insurance policies on each partner. In the event of a partner's death, the business uses the death benefit to buy out the deceased partner's share, streamlining the transition process.
Term life insurance is ideal for buy-sell agreements expected to end by retirement age or when lower premiums are essential. Permanent life insurance is preferable when the agreement covers scenarios beyond death (such as disability or retirement), serves as business collateral or is long-term.
Determining the Right Amount of Coverage
Weigh personal or business factors depending on your life insurance’s purpose. Use available resources to secure a policy that offers business continuity and financial stability for your family. Here are some tips:
Tally up personal debts like mortgages and loans. Consider future needs: children's education, retirement plans and other commitments. This comprehensive view ensures that coverage supports your family's future.
The financial health and size of your business are important in deciding coverage. Consider monthly and yearly expenses, from rent to salaries. Gauge the business's assets, liabilities and growth projections to refine the coverage, thus ensuring the business remains solvent in unforeseen circumstances.
Tools and Calculators
Online tools can help you navigate this decision. Here are online tools and calculators you can use:
- How Much Life Insurance Do I Need?
- Life Insurance Calculator
- Mortgage Calculator
- Cost of Living Calculator
While these tools are a good starting point, consulting with a financial advisor can offer tailored advice.
Understanding Costs and Premiums
Premiums can vary based on different factors, and it's essential to grasp what drives these costs. Here, we'll discuss the elements that influence premiums and offer insights on securing the best rates:
Factors Influencing Policy Costs
A blend of individual, business and macroeconomic factors determines life insurance premiums. Here’s what business owners need to anticipate to manage their insurance costs more effectively.
- Type of Policy: The choice between term or permanent insurance significantly affects the premium.
- Coverage Amount and Duration: The extent of coverage and the policy's term are pivotal in cost determination.
- Age: Younger individuals generally secure lower premiums as they represent a lower risk to insurers.
- Health Conditions: Chronic or severe health conditions can lead to elevated premiums. Regular health check-ups and proactive management of health issues can be beneficial.
- Lifestyle Choices: Habits such as smoking, excessive alcohol consumption or engaging in high-risk activities can increase premiums.
- Travel Habits: For business owners, frequent travel, especially to regions perceived as high-risk, might influence premium costs.
- Business's Financial Health: The company’s financial stability is a consideration, especially for policies tied to business continuity.
- Macroeconomic Environment: Broader economic factors, such as interest rates and market conditions, can influence insurance product pricing.
How to Get the Best Rates: Tips and Tricks
Besides shopping around to find favorable rates, here are other strategies that can lead to cost savings:
- Buy Early: Purchasing insurance at a younger age typically results in lower premiums due to reduced risk.
- Maintain a Healthy Lifestyle: Regular health check-ups, a balanced diet and tobacco abstinence can lead to more favorable rates.
- Transparent Financial Records: Present detailed and clear financial records to showcase business stability, potentially leading to better terms.
How to Buy: Steps and Recommendations
When purchasing life insurance as a business owner, consider these buying tips:
Working With Brokers vs. Direct Insurers
Help yourself decide between brokers and direct insurers using the table below:
Represent multiple insurance companies.
Sell policies directly from one company.
Provide a range of options from various insurers, allowing for comparison.
Offer policies specific to their company, limiting comparison.
It can potentially help in negotiating better terms due to their relationships with providers.
Terms are typically fixed, with less room for negotiation.
This might involve additional steps as brokers liaise between you and the insurance companies.
Typically, it is a more streamlined process since there's direct communication between you and the insurer.
It is ideal for those who want to explore multiple options and might need guidance.
Suitable for those who have a clear preference or are familiar with a specific insurer's offerings.
Finding the Right Insurance Provider
You should select your insurance provider carefully to ensure they understand your needs. Look for:
Opt for providers with a solid track record and positive reviews from other business owners.
Investigate the provider's financial health. Companies with strong financial ratings are more likely to be around when you or your beneficiaries need them.
Some providers offer products tailored specifically for business owners. These products can come with added benefits tailored to your unique needs.
Prioritize providers known for their responsive customer service. Timely assistance can be invaluable when navigating the complexities of business-related claims.
Application Process, Medical Exams and Underwriting
A meticulous evaluation of your health, personal details and business specifics is required to assess the risk associated with insuring you and to set appropriate coverage terms. Here are the steps to expect:
Begin by filling out an application detailing your personal life, health, and business particulars. This step provides the insurer with a foundational understanding of your profile.
Most insurers will require a medical exam to gauge your health status and any potential risks. Be transparent and accurate during this phase.
During life insurance underwriting, insurers will evaluate the risk of insuring you based on the provided information and medical results. This assessment will help determine your premium rates.
Revisiting and Adjusting Policies for Changing Needs
Life insurance should adapt to changing landscapes to ensure consistent relevance and value.
Periodic Policy Reviews
Life insurance demands regular attention to remain relevant to your current situation. Major life events (like marriage or childbirth) or business milestones (like mergers, acquisitions or strategy shifts) can change financial needs. Conduct policy reviews every few years or after significant changes to ensure relevant coverage and updated beneficiaries.
Adapting to Business Growth and Changes
A business's insurance needs can change with its growth trajectory or operational shifts. Factors like hiring more employees, downsizing or changes in high-ranking executives can alter insurance requirements. Adjusting policies in response to these changes ensures continued protection and cost-efficient premiums.
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- National Association of Insurance Commissioners.. "Interest Rates & Insurance." Accessed September 13, 2023.