Business owners are well-versed in making crucial decisions that affect both the current day-to-day operations and the future state of their respective companies. When it comes to the latter, an unforeseen death of a key person in the business has the potential to significantly alter the course of business. Choosing the right life insurance policy is one crucial decision that can help alleviate some of this burden and ensure seamless business continuity.

Here are just a few of the key considerations that business owners must make when researching and analyzing the available life insurance options.

What type of policy is suitable for business owners?

The two main types of life insurance for business owners to consider are term life insurance and permanent life insurance. From the singular lens of a business owner, term insurance offers the most straight forward solution by providing protection for a specific length of time. Term insurance could be suitable for business owners who intend to retire at a particular time or who want coverage for the duration of their tenure with the business.

However, when key members of the business intend to work indefinitely, permanent insurance could be a better fit. As its name suggests, permanent insurance provides lifetime coverage, and it also includes a savings component that can be accessed within the coverage timeframe.

How much coverage is enough?

Life insurance can be an incredibly effective tool to include as part of a business succession plan. Both term and permanent life insurance, for instance, can fund a buyout should a partner choose to purchase the remaining stake in the business upon another partner’s passing. Life insurance can also help cover debts and lost income. The amount of coverage a business needs will require some careful analysis of the business’ value (including future value), profit, outstanding debt, and other financial obligations that will require coverage upon passing.

Funding life insurance inside vs. outside the corporation

When considering life insurance, business owners have the option of funding their policies through their corporation or individually. There are a number of details to consider when making this decision:

  • The cost to fund a corporate-owned policy is lower when paid by a corporation rather than personally – assuming the corporation’s tax rate is lower than the personal tax rate.[1]
  • In general, life insurance proceeds from a personally owned policy are received tax free. The same result can be achieved through corporate ownership.
  • Individually owned life insurance can name any beneficiary, whereas it is advisable to name the corporation as beneficiary with corporate-owned life insurance. Both result in loved ones receiving the life insurance proceeds.
  • Corporate-owned life insurance does not offer protection from corporate creditors; in order to protect assets, it could be beneficial to own a policy inside of a holding company.

When deciding whether corporate or individual life insurance aligns with the financial goals of the business, it is worthwhile to sit down with an insurance advisor and weigh the pros and cons of each option.

Borrowing against a life insurance policy

The ebbs and flows of running a business can make access to cash an attractive feature of a life insurance policy. This makes the benefit of owning a policy with a cash saving component (permanent insurance) twofold: financial protection and the flexibility to borrow against the policy during the policy-holder’s lifetime.

In taking this approach, it is important to consider that there are multiple methods to withdraw and borrow which have differing tax consequences. In general, collateral loans are the most tax advantageous type. These loans are with financial lenders who take the policy as collateral for the loan.

Buy-sell agreements

Similar to a marriage, business partners don’t typically anticipate their partnership to end. Buy-sell agreements are put in place as a contingency should one partner exit the business, with price and terms laid out under the agreement.[2] Life insurance can be incorporated into a buy-sell agreement when each business partner takes out life insurance on the other, using the benefit upon death to purchase the deceased’s share of the company. This type of arrangement is imperative when there is more than one business owner, and life insurance is integral to achieving the results of that agreement.

The ultimate goal of a life insurance policy is for business owners to protect the businesses they worked so tirelessly to build, and to provide peace of mind for surviving stakeholders and family members. Contacting an advisor is the critical first step to achieving a suitable level of protection.

[1] https://www.bdo.ca/en-ca/insights/tax/tax-articles/corporate-owned-life-insurance-accumulate-wealth/
[2] https://www.policygenius.com/life-insurance/life-insurance-for-business-owners/