The Versatility of Life Insurance for Business Owners

The Versatility of Life Insurance for Business Owners


Whether your business is in its infancy or generating millions of dollars in profit, life insurance can not only play a role in keeping your business afloat in times of hardship but also be an effective tax planning and estate planning vehicle when your business is thriving.

Wow, what a versatile tool… indeed it is. Let me explain.

Key Person Insurance

Key people in your business include other owners, executives, and other employees that your business depends on to run smoothly day-to-day.  These individuals know the ins and outs of your business and replacing them would take time – these individuals are one of a kind. You’re Batman and they are your team of Robin’s.  If Robin disappeared how effective would you be at fighting crime? Well, you’re Batman so probably still pretty effective, but you get my point.

If one of your key people passed away unexpectedly, it could have a severe financial impact on the business. Depending on who dies, lenders may cut back credit, creditors may request immediate payment, employees and customers may lose confidence, and competitors may take advantage of the situation.

Since these employees are one of a kind, it will take time to find someone to replace him/her. During this time profits may weaken, which could seriously affect the financial well being of your company.

The impact of the above adversity can be reduced if the business purchases life insurance on the key members of the company. If a key member passes away, the business receives the life insurance proceeds – an influx of working capital. The proceeds can be used to meet immediate cash needs, find new employee(s), and provide assurance to creditors, employees and customers that the business will be OK.

Business Loan Protection

At times, it can be difficult to obtain adequate debt financing with reasonable terms for a small business. What’s their problem, don’t they know how successful you are / you’re going to be? I get it. However, I suppose lenders have guidelines they need to abide by.

The death of a business owner or another key executive can trigger creditors to demand immediate repayment of any outstanding business debts.

The death of a key team member can be financially straining enough as is. To have creditors demand loan repayments as well could cause liquidation of assets, or worse, the demise of your business altogether. 

Further, it is common for business owners to personally guarantee small business loans – any outstanding debt remaining after the liquidation of the company will need to be repaid.

Purchasing a life insurance policy on key executives can help protect the business from creditor demands and protect business owners or their estate from becoming personally liable for outstanding business debts.

Buy-Sell Funding

Are you a business owner? Do you have a shareholders agreement? No? Please, do that ASAP. It is a key component to comprehensive financial planning focusing on business succession. The business interest often accounts for a substantial percentage of the owner’s net worth.

A buy-sell agreement (buyout agreement) is an agreement between co-owners to reallocate a share of a business if an owner dies or leaves the business. The agreement requires the business share to be sold to the company or the remaining members of the business. Above all else, the main reason to do this is:

1)     Your business partner(s) probably does not want to work with your significant other in the event of your death.

2)     Your significant other probably has no interest in working for your business. S/he would rather be paid in cash for the value of the shares and move on with his/her life.

Buying back the shares from the deceased’s estate could cost a substantial amount of money, cash that the business may not have readily available.  To fund a buy-sell agreement, business owners will typically purchase a life insurance policy on one another. If one of the owners pass away, the business will receive an influx of capital to buyback the shares from the deceased owner’s estate.

Funding Capital Gains Tax on a Business at Death

When you pass away many people will be in contact with your family and business partners to mourn their loss. After all, you’ve been a loving parent, a wonderful spouse and a terrific friend to so many people.

You know who else is going to be calling? CRA… they want their tax dollars! Brutal, isn’t it?

A person who owns shares in a corporation, business assets or partnership interest will be deemed to have disposed of these properties at death.

What does this mean? I’m glad you asked!

Simply, it means a tax liability may arise in the form of a capital gain as the government is viewing your death as you ‘selling’ your share of the business. 

Right now, you’re probably having a Good Will Hunting moment, doing some serious mental math in your head as to what the approximate tax implications would be of the shares in your business. 

Your conclusion? Uhhh, there is not enough cash at hand to pay this enormous tax bill!

First, I must congratulate you for running such a successful business!

Second, you’re right, and what’s worse is that CRA does not care… they want their cold hard cash.

What do you do? Well, the share or partnership interest may have to be sold or business assets may have to be liquidated.

The alternative? Indeed, purchase a life insurance policy to cover the funds needed to pay the tax liability. Life insurance is valuable vehicle if your beneficiaries want to retain the property or share in your business.

Wealth Creation

As a business owner you are constantly looking for ways to pay less tax, seeing as the top marginal tax bracket in Ontario is 54%.  Outside of your RRSP and TFSA, what other ways can you defer / avoid paying tax on your investments?

An alternative to investing in GICs or other taxable investments is to fund a corporate life insurance policy using your corporate dollars. Once the insurance proceeds are received, they are not taxable to the corporation and an equivalent amount is added to the company’s capital dividend account (CDA). Any money inside of a CDA can be paid out tax free to shareholders as a capital dividend.

Equalizing an Estate

If you own a business and have children, where, say, one works for the business and one does not, you need to consider what would happen if you passed away. It often makes sense to leave the shares of the business to the child who is currently working in the business. The child who is not working in the business would rather receive dividends from the business than to see the profits reinvested each year; this can cause serious altercations between your heirs.

One solution is to leave the shares to the child working in the business and equalize things by leaving an insurance policy to the child not working in the business. 

Conclusion

Life insurance is a versatile financial planning tool, especially for business owners. As mentioned above, there are many reasons to consider incorporating life insurance into your business. The conversation can be depressing as no one wants to chat about their eventual death. However, the conversation can also be exciting as it will give you peace of mind that if anything were to happen to you, your family, business partners and employees will be well taken care of.

For additional questions reach out to me at david@stewartfinancial.ca.

__________

The photo above is of the Sigiriya rock fortress located near the town of Dambulla in Sri Lanka. To get a good look at this popular tourist attraction we actually climbed a rock called Pidurangala. What a great idea that was … not only was it far less expensive than climbing Sigiriya but there were barely any other tourists and we got a fantastic view of Sigiriya.

People always ask why we chose to go to Sri Lanka. Truthfully, we were looking to relax before we started our journey to India, Nepal and Myanmar. Initially, we wanted to travel to the Maldives but soon found out that it was way outside of the budget for two students. We looked for the next closest country to the Maldives and it was, you guessed it, Sri Lanka.

We are so thankful that we traveled to Sri Lanka – it is such a beautiful country and to this day, the friendliest people I have ever met.

Leave a Reply