Employee Compensation

Life insurance can be a valuable benefit used to enhance employee compensation packages.

One option would be for the company to purchase term life insurance on behalf of key employees.

Another approach would be to implement split-dollar life insurance.  This could be set up where the employer and employee split the cost of the life insurance premiums. Upon death of the employee, the company receives the cash value of the policy and the family receives the death benefit.  In this way, a split dollar arrangement allows the employer to "lend" money to the employee so he or she can purchase more insurance for their family.

Investing Through Insurance

As part of the exit planning process, the owner should evaluate how they will invest the proceeds from the sale.  There are several insurance programs that allow the owner to take portions of the proceeds and purchase insurance policies that grow in value over time.  This includes the following:

  1. Variable Universal Life
    The cash value can be invested in a wide variety of separate accounts, similar to mutual funds, and the choice is entirely up to the contract owner. The 'variable' component in the name refers to this ability to invest in separate accounts whose values vary—they vary because they are invested in stock and/or bond markets. The 'universal' component in the name refers to the flexibility the owner has in making premium payments. The premiums can vary from nothing in a given month up to maximums defined by the Internal Revenue Code for life insurance.

  2. Life Annuity Policies
    A life annuity is a financial contract in the form of an insurance product according to which a seller (issuer) makes a series of future payments to a buyer (annuitant) in exchange for the immediate payment of a lump sum (single-payment annuity) or a series of regular payments (regular-payment annuity), prior to the onset of the annuity.

    The payment stream from the issuer to the annuitant has an unknown duration based principally upon the date of death of the annuitant. At this point the contract will terminate and the remainder of the fund accumulated is forfeited unless there are other annuitants or beneficiaries in the contract. Thus a life annuity is a form of longevity insurance, where the uncertainty of an individual's lifespan is transferred from the individual to the insurer, which reduces its own uncertainty by pooling many clients. Annuities are often used to provide income during retirement.

  3. Guaranteed Return Investment Insurance Policies
    With interest rates being so low, one may consider investing through insurance polices that offer a fixed rate of return.  These should be carefully evaluated by an insurance professional, because the terms and condition of how this guarantee is implemented can be quite complex.

Tax Benefits of Investing in Life Insurance

Each year's earnings on the investment portion are not taxes, and the taxable gains on policies that are later cashed out can be reduced by the amount of the insurance protection the plan provided.  And if the policy holder dies, the gains are not usually taxed.

Flexibility of Investing in Life Insurance

The death benefit on a variable universal plan may be increased with a lump-sum payment, or borrowed against in the event of a pressing financial need. The ability to skip payments is also an advantage.  In certain types of insurance plans, the insured can control whether the money is invested in conservative or more aggressive options.  Life insurance can also be used to pass estates to multiple generations, without paying any generation-skipping taxes.

Disability Insurance

Exit planning should consider the possibility that the business owner might suffer a serious disability that impacts the future operations and success of the business.

Business owners need to evaluate if they need disability insurance to protect their families and also to protect the ongoing operation and profitability of their business, should they become unable to work due to a disability.

Two types of disability insurance are:

  1. Disability Overhead Protection Insurance
    This type of disability insurance is paid to the company to replace the cash flow impact of the owner not being able to fully work.
  2. Personal Disability Coverage
    Beneficiaries would receive regular payments until the disabled earner can return to work.

Disability insurance can also be a valuable part of an employee's total compensation package, if fully or partially paid for by the employer.

Buy-Sell Agreement

A buy–sell agreement, also known as a buyout agreement, is a legally binding agreement between co-owners of a business that effects transfer of ownership shares to the other owners if an owner dies, becomes disabled, is otherwise forced to leave the business, or chooses to leave the business.

An insured buy–sell agreement (triggered buyout is funded with life insurance on the participating owners' lives) is an excellent way to ensure the buy–sell arrangement is well-funded to purchase an owner's shares when the buy–sell event is triggered.

Insurance Review

As part of any exit planning process, it is recommended that a licensed insurance professional conduct an insurance review to determine if the seller:

  1. Is carrying too much, or the wrong type of insurance.
  2. Needs to change listed beneficiaries.
  3. Needs to restructure their insurance for new family members.
  4. Should implement an insurance backed buy-sell agreement.
  5. Could use insurance as a way to transfer part of their assets tax free.
  6. Should consider certain types of insurance to incentivize key employees to remain with the company.
  7. Should implement term insurance to protect the value of the business being sold until the sale date.
  8. Should establish income replacement insurance for their family.
  9. Should contract for disability insurance to protect both their family and the business.
  10. Should use insurance as a way to provided cash to pay for estate and gift taxes.