Many small or medium sized business owners don’t know how beneficial a business life insurance policy can be to a successful company or even what to do before starting up their own business. The truth is, regardless of size, all business owners need whole life insurance. It can help businesses break free from traditional bank loans, benefit their employees, and earn tax advantages.
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Big Business Lessons for Small Businesses
Between 2008 and 2009 Wells Fargo increased their whole life insurance holdings, in the form of Tier 1 Assets, from $5 billion to $20 billion. Many other companies, like General Electric and Wal-Mart have done the same. Why do these companies have whole life policies? What are the benefits?Here are a few reasons why whole life is good for business:
Whole life insurance is an ideal place for business capital
Whole life insurance for business owners has an advantage many other types of insurance don’t: It earns cash value. This cash value accumulates over time due to interest earned and dividends paid. Mutual life insurance companies have a responsibility to policyholders and distribute dividends based on profits earned over the course of a fiscal year. While the amount of the dividend paid may vary from year to year, mutual companies have successfully paid out dividends for over 200 years, even during crises like WWI and WWII, the Great Depression, the Great Recession, and pandemics like the Spanish Flu.
As a contractual owner of the insurance policy, the business owner has first rights to its accumulated cash value. When business expenses arise, the owner can use a policy loan, up to the amount of cash value in the policy, to cover business costs. Capital is then funneled back to the insurance company so funds will be available again for future business expenses. Business owners can take out multiple policy loans year after year.
Instead of paying high interest rates to a bank, the business owner finances their expenses in a way that allows them to recapture the cost of interest. Regardless of the amount of the policy loan, insurance carriers still pay the policyholder interest on the full cash value of the policy. The policyholder decides the payback schedule. The interest rate charged by the insurance carrier is typically lower than a traditional bank loan.
Business owners need whole life insurance because it’s the ideal place to store capital.
Whole life insurance can be used to attract and retain employees
When an insurance company issues a policy, they do so because it is determined that the owner of the policy will incur a financial loss when the insured passes away. The insurance industry calls it “insurable interest”. Because a business owner may incur a financial loss if a key employee dies, insurance companies generally let business owners have an insurable interest over their employees.
This gives business owners a very unique way to use business life insurance as an employee benefit. Instead of paying an “employer match” into a 401k plan (that is inherently subject to market risk), employers may open life insurance policies on their employees. The business owner receives a tax benefit for paying the insurance premium*. They also have the right to utilize the cash value of the policy, thereby increasing business cash flow. The business owner may assign the employee’s estate as the beneficiary of the policy or they can list their business as the policy beneficiary.
If an insured employee leaves the company, the business owner has the option to transfer ownership of the policy to said employee. This would potentially mean the employee would retain the cash value accumulated in the policy. The employee would reassign the beneficiary, possibly listing a family member, their estate, or a charity they support. If the policy hasn’t been paid-up, the employee would be responsible for any additional premiums. Read “How to Pay Your Policy Premium” for more information on how policy premiums are paid.
Business owners need whole life insurance because it helps retain employees.
Whole life insurance provides a business secession plan
One of the reasons businesses fail is lack of a succession plan. If a business partner passes away, often there aren’t finances in place to continue funding the business. Depending upon the estate plan of a business partner and how they wish their assets to be distributed, it may be necessary for other partners to buy up the portion of business owned by the former partner.
A type of policy called a “buy-sell agreement” provides for an ideal business exit strategy. In this instance, a whole life policy is purchased for each business owner. When one owner passes away, the surviving owner will use the death benefit proceeds of the business life insurance policy to buy the deceased business owners portion of the business from their estate.
These types of buy-sell agreements don’t only apply to the death of a partner. Business owners need whole life insurance in the event that one business owner leaves the business due to illness, disability, or retirement. When this happens their business life insurance policy contract is simply assigned to the remaining owner(s). The remaining owner(s) now have complete access to cash value, increasing business cash flow. Because whole life insurance policies are for the duration of life, the business will collect on the death benefit when the departing owner dies, even if it is many years after they have retired or otherwise left the company.
Whole life insurance protects the intellectual capacity of business partners and other employees
Similar to a buy-sell agreement, a strategy called a “key person” policy allows businesses to protect against the lost revenue resulting from the loss of key employees. Business owners are able to fund these policies and use policy loans to finance business expenses and future business liabilities. The policy’s death benefit provides business owners with capital that can be used to off-set the cost of filling voids created by the departure of key employees.
Whole life insurance provides business owners with unique tax benefits
There are several tax benefits associated with whole life insurance, which extend to the cash value growth while the insured is living, as well as to the death benefit after the insured has passed away. Business owners need whole life insurance because it provides a place to grow wealth tax free. With careful planning, distributions can also be taken tax free.
When it comes to taxes, even a contractor, freelancer, or someone else who is self-employed benefits from whole life insurance. These types of self-employed workers are responsible for more taxes, as their employer isn’t covering a portion their Social Security tax or Medicare tax. The tax advantages of whole life insurance can help off-set these expenses.
The tax benefits of whole life insurance for business owners include tax-free retirement income, tax-free policy loans, and tax-free use of the growth of cash value. Plus, policies earn interest and dividends tax free. The death benefit of a policy also has tax advantages.
The IRS considers death benefit proceeds to be inheritance and not income to an estate, so they are passed on income tax free. There are estate-planning strategies that ensure that the death benefit proceeds are not included in the estate tax calculation.*
Life insurance for business owners is an excellent asset that can be utilized, as it provides flexibility, growth and security. Many Fortune 100 and 500 companies have utilized the power of whole life insurance for decades. Whether you are a large or small business, owning business life insurance should be one of your first priorities. To maximize the benefits of whole life insurance for your business, with a Wealth Strategist.
Watch: How to Protect Your Policy
*Paradigm Life is not an accounting firm or estate-planning attorneys. Paradigm Life encourages you to seek the services of a qualified tax advisor and estate-planning attorney.