Life insurance for owners of closely held businesses is one tool for protecting the future of both the business and its stakeholders. But before diving into how life insurance fits into business planning, it’s important to define what constitutes a “closely held business.”
What Is a Closely Held Business?
A closely held business is typically a privately owned company with a small number of shareholders. These businesses are often family-owned, owned by a small group of partners, or held by a limited group of investors. A key of these businesses is that their stock is not available for public trading, which means the ownership is more concentrated and often involves long-term relationships between the owners.
How Life Insurance Can Benefit a Closely Held Business
Life insurance can serve multiple purposes for closely held businesses. Here are some of the primary ways it can be used:
Business Continuity
Life insurance can be used for buy-sell agreements by the remaining partners. It can be used as a tool to provide them with the funds necessary to buy out shares that belonged to the deceased owner, which can ensure that the company can continue smoothly without needing to sell off assets or involve outside parties.
Key Person Insurance
Many closely held businesses rely heavily on certain individuals—whether they are business owners, partners, or key employees. Life insurance can be used to protect the business against the financial impact of losing a key person unexpectedly. The proceeds can help cover lost revenue, recruit and train a replacement, or stabilize operations in the transition period.
Estate Planning and Tax Considerations
Life insurance is also a useful tool in estate planning. When a business owner passes away, their estate may be subject to estate taxes, which could require the liquidation of business assets. Taxes need to be covered, and purchasing life insurance is one way the business owner can create liquidity to cover them. It also can create a way for the family or heirs to not have to sell the business to pay the estate tax.
Equalizing Inheritance
Life insurance can be used for family-owned businesses to equalize inheritance among heirs. If some heirs will inherit the business while others do not, life insurance can provide the non-business heirs with an equivalent value, helping to avoid family disputes and ensuring fairness.
Employee Retention and Benefits
Life insurance can also be part of an executive compensation strategy. Non-qualified deferred compensation (NQDC) plans that are funded by life insurance can help retain valuable employees; another way to offer them benefits not tied to traditional retirement plans. This can be especially important for key executives who are critical to the company’s success.
Understanding the Different Types of Life Insurance
Several types of life insurance policies can be used in business planning. The decision is dependent on the needs and objectives of the business:
- Term Life Insurance: Provides insurance coverage for a specific period (i.e. 10, 20, or 30 years). It is also typically the most affordable option but does not accumulate cash value.
- Whole Life Insurance: Provides lifetime coverage and includes a cash value component that grows over time. It is more expensive than term life insurance but offers long-term benefits.
- Universal Life Insurance: A flexible policy that combines permanent coverage with adjustable premiums and death benefits. It also includes a cash value component.
Don’t Leave Life Insurance Out of Business Planning
What would happen if a business owner or key employee were to die unexpectedly? Without adequate life insurance, it could face significant challenges, from problems with business continuity and addressing estate tax concerns to potential financial insecurity. Proper planning and coverage can help business owners avoid unnecessary financial strain and preserve the stability of the business for both the current generation and future heirs.
Incorporating life insurance into the financial strategy of a closely held business can provide safeguards for the company and protection for owners and families. It can also ensure a smoother transition in the event of an unexpected death. Carefully considering your business’s needs, consulting with professionals, and selecting the appropriate type of insurance can make life insurance a valuable part of your long-term business planning. Contact one of our estate planning or business attorneys to discuss your business’s situation.
