As a business owner, insurance is not just about protecting your business; it’s about safeguarding the people who make it thrive. Life insurance policies can provide a safety net for shareholders and their families, ensuring their financial security in the face of unforeseen circumstances. These policies also benefit the corporation by enhancing cash flow through collateralized loans. Let’s delve deeper into these advantages.
Shareholders’ Agreement
A shareholders’ agreement is one of the most important documents for a business to have because it addresses several important aspects relating to share ownership, such as:
- Issues relating to who can own/buy/sell shares
- What happens upon the death/disability or bankruptcy of a shareholder
- Typically contains a right of first refusal and methods of dealing with offers from third parties
- Other issues include dividend policy, employment terms, non-competition, etc.
In corporations with multiple shareholders, a well-crafted agreement is not just a legal requirement, it’s a strategic move. It ensures a seamless transition after the unfortunate event of a shareholder’s death. Even successful businesses can face financial challenges when it comes to buying out a significant shareholder. Without proper funding, the deceased’s spouse or child could become an unintended partner. This is where insurance steps in, providing immediate funding to purchase shares and maintain business continuity.
Insurance on the lives of shareholders ensures immediate funding will be available to purchase their shares in the event of death or disability. This insurance option is not only convenient but also cost-effective, often more so than other funding methods like borrowing money, liquidating assets, creating cash reserves, or using after-tax corporate profits. Moreover, shareholders can leverage the tax-efficient nature of life insurance to achieve their estate planning goals, providing a sense of financial reassurance.
Always bear in mind the importance of periodically reviewing the corporation’s value. This proactive measure ensures that the buy/sell is adequately insured and that the amount of coverage continues to increase with the business, instilling a sense of responsibility and foresight.
A NOTE ABOUT TAXES: On the shareholder’s death, the corporation receives the life insurance benefit tax-free and generates a credit to the Capital Dividend Account (CDA). The CDA can, in turn, be paid tax-free to the shareholder’s estate. The CDA is a valuable tool that can be used in post-mortem planning to remove potential double tax on a shareholder’s death.
Other Uses of Corporate-Owned Insurance
Key Person Insurance – This coverage is familiar to small- to medium-sized businesses with one or more key people whose death, disability, or critical illness would significantly hurt the organization. Often, people think of a key person as only a shareholder; however, a key person can also be a hired executive or anyone whose death, disability or departure will harm the business’s financial health. The most common formula in determining coverage is 5 to 10 times the person’s compensation.
Collateral – It is pretty standard for lenders (banks or other financial institutions that lend funds to small businesses) to ask the borrower to provide life insurance on the lives of critical shareholders or employees as a condition of lending. Having the right insurance in place will help your position if this need should arise. The loan interest may be deductible, subject to certain conditions, which is also financially advantageous.
Charitable Giving – Just as insurance can be an effective tool for individuals to donate to charity, corporate insurance can likewise be used tax effectively. Either new or existing corporate insurance policies may be used to benefit a charity in different ways, such as:
- Policy ownership assigned to the charity
- Corporate-owned policy used to fund an estate gift
- Corporate-owned policy used to fund corporate gifting
Estate Protection—Insurance can provide a tax-efficient way to enhance or create an estate. It can also pay taxes due upon death, thereby protecting the estate’s value for the beneficiaries.
Estate Equalization—It’s common in family-owned businesses that not all the children want or are suited to work within the business. Yes, the parents want to see the child who continues to run the business inherit it, but they also want to see their other children dealt with fairly. A solution that can help is life insurance, which delivers liquidity when it is needed most.
Your life, your family, and your business deserve protection. Insurance can not only help provide that protection but can also help you build assets in a tax-effective way for your retirement or estate plan.