Life Insurance: A Must-Have For Small Business Owners?

Life insurance is an important consideration for small business owners. While it is not a legal requirement, it can provide financial protection for a company in the event of the owner's death. It can also protect the owner's family, partners, and employees. There are several types of life insurance policies that small business owners can choose from, including personal life insurance, key person life insurance, and buy-sell agreements. These policies can help ensure the continuation of the business, provide income for loved ones, and cover expenses. Ultimately, the decision to purchase life insurance depends on the specific needs and circumstances of the small business owner.

Buy-sell agreements

A buy-sell agreement, also known as a buyout agreement, is a contract funded by a life insurance policy that can help minimize the turmoil caused by the sudden departure, disability, or death of a business owner or partner. It is a legally binding contract that stipulates how a partner's share of a business may be reassigned if that partner dies or otherwise leaves the business.

There are two common types of buy/sell agreement life insurance plans:

Cross-Purchase Plan

In a cross-purchase plan, each business owner buys a life insurance policy on each of the other owners. When an owner dies, the remaining owners use the payout from the life insurance policy to buy the deceased owner's share of the business. This type of plan is generally used with businesses that have two owners.

Entity Purchase, or Stock Redemption, Plan

In an entity purchase, or stock redemption, plan, each employee-owner enters into an agreement with the business to sell their interest in the business. As part of the agreement, the business buys life insurance policies on the lives of each owner. The business pays the premiums and is the owner and beneficiary of the policy. When an employee-owner dies, that share of the company passes to the heirs of their estate, and the business can use the policy's death benefit to buy the interest from the estate.

Advantages of Buy-Sell Agreements

Disadvantages of Buy-Sell Agreements

One disadvantage of buy-sell agreements is that they can make it harder for business owners to sell their interests to anyone not mentioned in the agreement. The purchase price might also become dated and value the stake too high or low for the current business environment. The cost of getting a lawyer to draw up the agreement can also be expensive.

Key person insurance

While life insurance is not a legal requirement for small business owners, it is an important consideration for the continued operation of the business and protection of the owner's family.

This insurance provides a financial cushion for the business, helping to protect against the negative impact on operations that could occur if a key person were to pass away or become disabled. The death benefit can be used to recruit and train a replacement, pay off debts, distribute money to investors, and/or provide severance benefits to employees.

For small businesses, the key person is usually the owner, founder, or a key employee. The main consideration is whether the absence of this person would cause significant financial harm to the company. If so, key person insurance is worth considering.

The cost of key person insurance will depend on various factors, including the health, age, and gender of the insured individual, as well as the size, nature, and industry of the business. The amount of insurance needed will depend on the role of the key person and the size and nature of the business.

In addition to providing financial protection, key person insurance may also improve a company's creditworthiness by lowering business risks. It can also facilitate the sale or transition of a business by providing an extra layer of business continuity protection.

Individual life insurance

When purchasing an individual life insurance plan, it's important to buy enough coverage to manage both your personal debts and living expenses for your family, especially if they are solely dependent on your business income. This type of insurance can also help your family avoid liquidation, pay estate taxes, and carry on operations for your clients.

There are two main types of individual life insurance: term life insurance and permanent life insurance. Term life insurance is designed to last for a specific number of years, such as 10, 20, or 30 years, and is generally more affordable. On the other hand, permanent life insurance stays in force throughout the insured's entire life, unless the policyholder stops paying the premiums or surrenders the policy. This type of insurance is more expensive but offers the advantage of lifelong coverage.

When deciding between term and permanent life insurance, consider your budget, the size of your business, and how you want ownership to be handled after your death. Additionally, consult with a financial advisor or insurance agent to ensure you're making the right choice for your personal and business needs.

Group life insurance

There are several ways to structure group life insurance for a small business:

• Offer group life insurance as part of an employee benefits package. If the company pays the full cost, employees will automatically receive the coverage.
• If you expect employees to pay all or part of the cost, the coverage will be optional.
• Pay for a certain amount of coverage and offer employees the option to increase the limits at their own expense.
• Allow employees who leave the company to retain their life insurance coverage and pay for it directly. They can also typically convert the policy from term to whole life.

As a small business owner, it's important to work with an agent who understands the market and the different insurance options available.

Personal life insurance

A general rule of thumb is to have a personal life insurance policy that is 10 times larger than your annual income. However, it is recommended to use a life insurance calculator for a more accurate estimate.

Additionally, if you have business partners, personal life insurance can help fund a buyout of your share in the business. This is typically done through a buy-sell agreement, where business partners take out life insurance policies on each other. This ensures that your partners have the financial means to purchase your share of the business upon your death.

Overall, personal life insurance is an essential tool for small business owners to protect their families, cover personal debts, and facilitate business continuity in the event of their death.

Frequently asked questions