Business Owners: Life Insurance Through Your Company?

Life insurance is a crucial consideration for business owners, and it's important to understand the different types available and how they can be structured. Firstly, there's personal life insurance, which is essential for income replacement and protecting your family from debts in the event of your untimely death. This is especially important for business owners, who may not have access to employee benefits such as group life insurance or retirement accounts. Secondly, there is key person or key man life insurance, which is owned by the business and covers essential personnel like owners, stakeholders, and top executives. This type of insurance helps ensure the business's survival by providing financial protection in the event of the death of a key individual. It's worth noting that premiums for key person insurance are generally not tax-deductible, and there are specific notice and consent requirements to ensure the insurance is exempt from income tax when received. Lastly, co-owners of a business should consider a buy-sell agreement, which dictates what happens to each owner's share of the company in the event of their death or departure. This can be structured as a cross-purchase agreement or an entity purchase plan, both of which involve life insurance policies to facilitate the buyout process.

Tax deductions for life insurance

Life insurance premiums are generally not tax-deductible as the IRS considers them personal expenses. However, there are a few specific scenarios where you can deduct life insurance premiums on your tax returns.

For Employers

If you are an employer offering life insurance as an employee benefit, you can deduct the premiums as a business expense. However, this deduction is only applicable if the business or business owner is not the beneficiary of the policy. Additionally, the deduction is limited to the cost of $50,000 of coverage per employee. Any amount paid for coverage above this limit is considered employee wages and is not tax-deductible.

For Self-Employed Individuals

Self-employed individuals can deduct life insurance premiums as a business expense in certain situations. If you have a life insurance policy intended to protect your business assets, the premiums may be tax-deductible. However, it is important to consult with an accountant or tax professional to determine the eligibility and criteria for deductibility based on your specific circumstances and tax status.

For Alimony Agreements

Life insurance premiums may be tax-deductible if you have an alimony agreement or divorce decree that requires you to pay for life insurance on your ex-spouse, as long as the agreement went into effect before 2019. Any alimony agreements that took effect in 2019 or later are not eligible due to changes in the tax code.

For Charitable Donations

If you donate your life insurance policy to a charity, any premiums you pay towards the policy after the date of the donation are tax-deductible. This option is commonly used by individuals with a high net worth to reduce their taxable assets. However, it may not be suitable for those who want to ensure their family's financial support upon their death.

Key person life insurance

The loss of certain key employees can have a devastating impact on a business. Key person insurance provides a critical financial cushion to help stabilise the business while leadership decides on a new way forward. The death benefit buys the company time to recruit and train a replacement, or to implement strategies to save or shut down the business.

Key person insurance is also available as disability coverage, which can be used to cover the costs of training and education if the insured becomes incapacitated and can no longer work.

When deciding whether to take out key person insurance, companies should consider the financial impact that the loss of the key person would have on the business. The cost of coverage will depend on the size and nature of the business, the role of the key person, and the type of policy.

While premiums paid for key person policies are generally not tax-deductible, any cash value that builds up in a permanent policy is tax-deferred, allowing the policy to compound more interest.

Personal life insurance

The goal of personal life insurance is to cover expenses in the event of the policyholder's death. Business owners should have legal protections in place to safeguard their personal assets, but a larger death benefit could cover outstanding business debts while also making up for a sudden loss of income.

Although surviving family members are generally not responsible for business debts, the right personal life insurance policy can help keep important business assets out of the hands of creditors. Personal life insurance benefits can also be specified to allocate a portion of the money from the death benefit to business expenses as the company recovers from the loss of the policyholder.

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

Buy-sell agreements

A buy-sell agreement is a contract created by business owners to ensure that, in the event of a member's death, disability, or retirement, their ownership interest will be sold to the remaining partners or the company. This type of agreement is particularly critical for closely held businesses, as it helps maintain stable ownership and prevents outsiders from acquiring ownership interests.

There are several ways to structure a buy-sell agreement, including redemption agreements, cross-purchase agreements, and hybrid agreements. In a redemption agreement, also known as an entity-purchase agreement, the company buys back the ownership interest of the exiting owner. In a cross-purchase agreement, the remaining owners purchase the exiting owner's share. A hybrid agreement offers flexibility, allowing either the company or the remaining owners to buy the exiting owner's share.

Life insurance is commonly used to fund buy-sell agreements. Each business owner takes out a life insurance policy with the other members or the company as the beneficiary. The face amount of the policy is equal to the value of the member's ownership interest. Upon the member's death, the policy pays out to the company or remaining owners, providing the funds needed to purchase the deceased member's share.

Business debt protection

Business owners often have a greater need for protection than most, as employees rely on them for job security and businesses may have to manage debts and other finances. Life insurance can be a valuable safety net for your loved ones and your business in the event of your death.

Business Debt and Family Income Protection

A business debt and family income protection plan can be funded by life insurance. In this scenario, your business purchases a life insurance policy on you, with the business as the owner and beneficiary. The business then receives the insurance payout, which is generally tax-free, and can be used to pay off debts and mortgages, as well as provide an income for your family.

Life Insurance for Business Owners

As a business owner, you can secure personal life insurance benefits to protect your family. Additionally, you can specify that a portion of the money from your death benefit be allocated to business expenses, such as supplier contracts, employee salaries, and daily operating expenses. This can help keep the business afloat while your successors plan for the future.

Types of Life Insurance for Business Owners

There are several types of life insurance policies to consider as a business owner, including term life, whole life, permanent life, and key life insurance. Term life insurance is the most common and affordable option, providing coverage for a specific period, usually 10 to 30 years. Whole life insurance offers lifelong protection as long as premiums are paid and is the most popular permanent life insurance option. Permanent life insurance includes whole life, universal, and variable universal policies, offering tax advantages and investment opportunities. Key man or key person life insurance is designed to protect business assets and is crucial for larger operations.

Using Life Insurance to Pay Off Business Loans

Life insurance can be used to pay off business loans that your partners or successors may be responsible for after your death. It can also fund a buy-sell agreement, allowing partners to buy out the deceased partner's stake in the company.

While life insurance for business owners is not tax-deductible in most cases, it can provide financial security and peace of mind, ensuring that your business and loved ones are protected.

Frequently asked questions