Part One- Two cases using life insurance.
Over the years I have seen clients and advisors get hung up on which type of life insurance they should purchase, permanent or term insurance, making their situation much more complicated than it must be.
In this article I want to break down the different situations where life insurance is needed and what type of life insurance I would recommend. Again, this is my opinion, but it is based on several facts within the situation.
Example 1 – Young Business Owner with A Growing Business
Our client is running a business and is investing much of his discretionary dollars into the business. His wife is a nurse and makes good income. This helps him support the family while building his business.
He has two young children, a mortgage, and a business loan. They are not concerned about income replacement at his death, as his wife can work anytime and anyplace as a nurse. However, they are concerned about debt, business debt and the college costs for the kids. The capital required was $1,000,000
His earnings have been increasing consistently for the past five years, and his business has been stabilizing while growing. The income from the business is more predictable and, in a few years, he feels it will be easier to budget.
In this case I suggested he purchase a 20-year term convertible term insurance plan.
- The premiums are affordable and low
- the term of the insurance would be adequate
I could have suggested permanent life insurance under a split dollar or bonus plan however, I felt it would impede his ability to save money in his business and continue to expand.
Case 2-The Sole Proprietor with No Market
The problem with owning a sole proprietorship, is in many cases there is no market to sell the business. These small companies create a job for the owner, a salary, and a place to go. It affords them a good standard of living, and enjoyment in their work. The problem, however, is at their death, a long-term illness, or a cash flow crunch, or loss of key employees, they do not have a market to sell too immediately.
One of the greatest risks is dying while owning the company. The business is too small for the open market, and normally there are a handful of employees who do not have an interest in or the money to purchase the business.
This is a time that the estate in many cases needs the cash to settle estate expenses.
Competitors are more than happy to lend a helping hand by offering 10-20 cents on the dollar for the assets.
As a planner, I can help them!
I can arrange to have a buyer ready at any time to provide the spouse or estate of the owner, the going concern value of the business.
The payout would be tax free. The cost could be from 1/2% to 2% of the value put on the business.
If the cost were 1% for example, and the business was worth $250,000, the owner would pay $2,500 a year for this guarantee.
If the owner decided to sell the business to a willing buyer, the owner would receive back part or all their cost for the arranged guaranteed purchase.
The “Arrangement” at death is that the spouse/estate would receive tax-free the $250,000 purchase value! The spouse/estate could also keep the business, and sell the assets or the business (piecemeal, or the whole business).
If the owner of the business had retired and sold the business to an outsider or another family member, the arrangement would return to the owner all the deposits the business owner contributed to the “Arrangement” over the years, plus a reasonable interest rate to help them in retirement.
Not a bad plan when you consider the “Arrangement” is guaranteed if the business owner paid their 1% to the arrangement.
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