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The Benefits of Life Insurance for Small-Business Owners

June 07, 2023

Life insurance can hold significant advantages for small-business owners, going beyond the typical motivation of providing financial security for their families in the event of their passing.

Owning a business doesn't automatically equate to readily available cash or liquid assets. Often, the true value of a business lies in its long-term potential and may only be realized through its sale. This situation leaves surviving family members relying solely on the business's cash flow. To mitigate this risk, life insurance can provide the necessary liquidity to cover expenses and maintain financial stability.

Another crucial reason business owners consider life insurance is to ensure sufficient funds to pay estate taxes upon their death. Estate taxes are typically due in cash within nine months after the policyholder's passing. In such situations, families may need immediate cash to meet tax obligations, resorting to borrowing or hastily selling the business under duress. Life insurance is frequently utilized to avoid these pressure scenarios.

From a personal perspective, life insurance can promote fairness in inheritance, particularly when a business owner has children involved in the company alongside other children who are not. By leaving the business to involved children and designating life insurance proceeds to non-involved children, family members are better positioned financially and in maintaining harmonious relationships.

Co-Ownership Considerations for Life Insurance

Life insurance also plays a pivotal role in cases of business co-ownership. Two common types of buy-sell agreements exist cross-purchase agreements and entity purchase agreements.

Cross-purchase agreements involve business owners obtaining life insurance policies on each other. If one partner passes away, the surviving owners can use the death benefits to buy out the deceased partner's stake from their estate.

Entity purchase agreements, on the other hand, involve the company owning insurance policies on co-owners lives. In the event of a co-owners death, the company receives the death benefit and utilizes it to acquire the deceased owner's stake. The purchased shares then become treasury stock. Entity purchase agreements are particularly useful when multiple partners are involved, as they eliminate the need for each partner to hold a life insurance policy on every other partner.

Defining Fairness and Communication Within the Family

The concept of fairness varies from one family to another, and it is essential for business owners to define what fairness means in their specific circumstances. Fairness does not always equate to equality, and it is up to the policyholder to determine what they consider appropriate rather than leaving the decision solely to the beneficiaries, who may have differing views.

Effective communication within the family before the policyholder's passing is crucial. Openly discussing the plan, mainly if it includes elements that may be perceived as favoring one beneficiary over another, fosters understanding and reduces potential conflicts. These conversations provide an opportunity for beneficiaries to grasp the intentions behind the decisions and realize that any inheritance is a gift given out of love and generosity.

Life insurance is a versatile tool that provides liquidity, covers estate taxes, and helps achieve fair inheritances, often benefiting a small business owner's business and personal life.

Our team of experienced financial advisors at IM Wealth Partners is here to help you achieve your financial goals. We take a comprehensive approach to financial planning and provide personalized solutions tailored to your unique needs. Contact us today to learn more about our services and how we can help you achieve financial success.