CONTINUATION: PART II (CASE 3&4)
Case Examples of When to Use Life Insurance and The Type to Use!
Case 3 and Case 4
Example 3 – The Buy and Sell Funding
The company has three owners, should one of them die, the surviving partners would have to buy out the survivors of the deceased partner. They have four choices for the funding of this potential liability. The agreement states the stock must be purchased by the owners, or the entity:
1. Sinking Fund
2. Borrow the money
3. Payout over a period
4. Life insurance
When looking over the costs, life insurance was by far the least expensive compared to the other options, and tere where assorted reasons why some of the options did not make a lot of sense:
Borrowing the money; if they could get the loan, (doubtful that a bank would loan money to a company that just lost a key owner), it would cost principal and interest and may have an impact on the profit and loss statement.
Sinking fund; Unless they put money at risk, they would have to settle for an exceptionally low rate of return (near 0). Plus, if death happened sooner rather than later, they would not have saved enough to pay the liability needed to purchase the interest. Also, the sinking fund would cause them to commit a much larger contributions to the plan, thus eliminating cash to invest in their company.
Life insurance: This was a cost of 1% of capital for a guaranteed payment. In this case, we could have used term, however, at some point the owners would have to change the plan over to a permanent coverage type of plan. This would give them a guaranteed premium and longevity to the plan, to fund their buy and sell.
The liability of purchasing the partners’ shares, is a long-term proposition, possibly lasting generations. Permanent life insurance was the reasonable choice. The life insurance had “double duty dollars”, allowing them to use the cash value to purchase the partners out in the future when they retired.
Example 4–Keep the Star Key Man
The owner of a successful business wanted to make sure they enticed the key person running the business to stay with the firm. The key person makes things happen in the firm. It allows the owner to take more time off, create more profits, and they benefit from the efforts of the key person.
We put in a supplemental retirement plan, just for the key person, and the owner was willing to invest $30,000 into an executive compensation plan. When the funding was discussed by the team of advisors, which were consisted of the CPA, attorney, the business partner, business consultant, and I, the following suggestions were made:
– Put money in a mutual fund
– Give the employee stock of the company
– Purchase cash rich life insurance program
– Have company stockbroker build a stock portfolio for the key person
When it was all said and done, the life insurance program on a permanent basis was the clear winner:
– Benefits would be paid tax-free to the employee at retirement
– The contributions would have little if any impact on the key person’s income tax opposed to the other methods
– If the key person died before retirement, the insurance plan could complete a tax-free benefit he would have received had he retired, giving his family protection and security. The other options did not have that available.
– The life insurance plan had guarantees, while the other suggestions did not
- The Employer had an arrangement to recover their full cost to the plan, where the other programs had a “charge to earnings” against the company.
Adding it up, the cash rich life insurance was a very clear winner.
I have given you four uses of life insurance. In each situation, the question to use term insurance, or permanent comes into plan. There are a few simple questions to ask:
A. Is the reason for the insurance permanent or short term.
B. If it isn’t long term today, will it end up being long term.
C. If it is determined that the need for the insurance is less than 15 years, without exception use term?
If the answer is long term, or if it will be long term, I have used term if there was a cash flow issue, but with the idea of changing the plan when cash flow permitted.
FOR A FREE ASSESSMENT OF YOUR BUSINESS INSURANCE PLANNING TAKE OUR FREE ONE MINUTE ASSESSEMENT!
You will receive a free report and a free 30-minute conference discussion FREE INSURANCE ASSESSMENT