Skills without mastery are useless. Mastery is impossible without the right methods. SimpliGrok platform makes mastery effortless and fastest with proven, smart practice.
Skills without mastery are useless. Mastery is impossible without the right methods. SimpliGrok platform makes mastery effortless and fastest with proven, smart practice.
Life insurance serves many important business purposes beyond personal protection. Business owners use life insurance for key person protection, business succession, executive benefits, and employee retention.
Protect business from financial loss due to death of key employee.
Essential to business success:
- Owner/founder: Creator of business
- Top executive: CEO, CFO, COO
- Key salesperson: Major revenue generator
- Specialized expert: Unique knowledge or skills
- Important relationship: Key client relationships
Test: Would the business suffer significant financial loss if this person died?
Structure:
1. Business is owner: Company owns policy
2. Business is beneficiary: Company receives death benefit
3. Business pays premiums: Company pays all premiums
4. Insured is key person: Policy on key employee's life
Example:
Key person: Founder/CEO
Policy owner: ABC Corporation
Insured: Founder
Beneficiary: ABC Corporation
Face amount: $2 million
Premium payer: ABC Corporation
When key person dies, business uses proceeds to:
- Maintain operations: Cover revenue loss during transition
- Recruit replacement: Pay search firm, relocation, signing bonus
- Train new person: Time and cost to get up to speed
- Pay debts: Meet obligations if credit affected
- Reassure lenders: Demonstrate financial stability
- Retain employees: Prevent exodus due to uncertainty
- Buy out deceased's interest: If also owner
Methods:
Multiple of salary:
Annual compensation: $200,000
Multiple: 5-10 times
Coverage: $1,000,000 - $2,000,000
Contribution to profits:
Key person generates: $500,000 annual profit
Years to replace: 3-5 years
Coverage: $1,500,000 - $2,500,000
Business valuation impact:
Business value with key person: $10 million
Value without key person: $6 million
Loss: $4 million
Coverage needed: $4 million
Premiums:
- Not tax-deductible: Business cannot deduct premiums
- Business expense: But not deductible expense
Death benefits:
- Income tax-free: Death benefit not subject to income tax
- Increases net worth: Adds to business value
Cash value:
- Asset of business: Shows on balance sheet
- Tax-deferred growth: Increases without current taxation
Example:
Annual premium: $20,000
Paid by: ABC Corp
Tax deduction: $0 (not deductible)
Death benefit received: $2,000,000
Income tax: $0 (tax-free)
Available for: Business use
Ensure orderly business transfer when owner dies, retires, or becomes disabled.
Owner dies:
- Heirs own business: But don't work in business
- Surviving owners stuck: Can't get rid of inactive owners
- Heirs want money: But business has no cash
- Forced sale: May have to sell at discount
- Disputes: Disagreements over value, control
Legal contract requiring:
1. Obligation to sell: Deceased owner's interest must be sold
2. Obligation to buy: Survivors must buy the interest
3. Pre-determined price: Formula for valuation
4. Funding mechanism: Life insurance provides cash
Owners buy from each other:
Structure:
- Each owner buys policy: On each other owner
- Owners are beneficiaries: Of policies on others
- When owner dies: Survivors use proceeds to buy deceased's interest
Example - 3 Partners:
Partner A owns policies on B and C
Partner B owns policies on A and C
Partner C owns policies on A and B
Total policies: 6 policies (each partner on each other)
Partner A dies:
B and C receive death benefits from their policies on A
B and C use proceeds to buy A's interest from estate
B and C now own 50% each (2-way split)
Advantages:
- Step-up in basis: Surviving owners get stepped-up basis in purchased interest
- Personal ownership: Owners control their own policies
- Tax-free benefit: Death benefits income tax-free
Disadvantages:
- Multiple policies: n × (n-1) policies needed [3 owners = 6 policies]
- Premium disparity: Older/less healthy owners pay more
- Complexity: More policies to manage
- Age differences: Premiums vary significantly
Basis step-up example:
Partner A's original basis: $100,000
Purchase price paid: $500,000
New basis for B and C: $600,000 ($100,000 + $500,000)
Benefit: Higher basis reduces future capital gains tax
Business buys from deceased owner's estate:
Structure:
- Business owns policies: On each owner
- Business is beneficiary: Receives death benefits
- Business buys interest: Redeems deceased owner's shares
Example - 3 Partners:
ABC Corp owns policy on Partner A
ABC Corp owns policy on Partner B
ABC Corp owns policy on Partner C
Total policies: 3 policies
Partner A dies:
ABC Corp receives death benefit
ABC Corp buys A's interest from estate
B and C ownership increases proportionally (now 50% each)
Advantages:
- Fewer policies: Only n policies needed [3 owners = 3 policies]
- Equal premiums: Business pays all, owners share cost equally
- Simplicity: Easier to administer
- One buyer: Business is sole purchaser
Disadvantages:
- No basis step-up: Surviving owners don't get increased basis
- Corporate funds: Uses corporate money
- Accumulated earnings: May face accumulated earnings tax
- Alternative Minimum Tax: May trigger AMT issues
Flexibility:
- Decide later: Determine at death whether cross-purchase or entity
- Tax planning: Choose most favorable structure
- Best of both: Combines advantages
Agreement must specify how to value business:
Fixed dollar amount:
Business worth: $3 million (agreed value)
Update annually: Review and adjust
Problem: Often not updated regularly
Formula approach:
Book value: Net assets value
Capitalized earnings: Earnings × multiple
Revenue multiple: Revenue × industry multiple
Appraisal:
Independent appraiser determines value at death
Most accurate but expensive
Example:
3 equal partners
Business value: $3 million
Each partner's share: $1 million
Insurance on each partner: $1 million
Partner A dies:
Estate receives: $1 million for A's 1/3 interest
Survivors get: A's interest
New ownership: B and C each own 50%
Life insurance ideal because:
- Creates instant cash: Death benefit available immediately
- Income tax-free: Proceeds not subject to income tax
- Guaranteed funding: Amount certain at death
- No liquidation: Don't have to sell business assets
- Estate liquidity: Heirs get cash, not illiquid business interest
Separate agreement for disability:
- Disability income insurance: Provides funds to buy out disabled owner
- Waiting period: Typically 12-24 months
- Buyout over time: Often structured as payments over 2-5 years
Reward and retain key executives with life insurance.
Structure:
1. Employer pays premium: On policy for executive
2. Executive owns policy: Executive is owner and beneficiary
3. Premium is bonus: Taxable compensation to executive
4. Employer deducts: Employer deducts premium as compensation
Example:
Executive compensation: $200,000
Bonus (premium): $10,000
Total taxable income: $210,000
Employer:
- Pays $10,000 premium
- Deducts $10,000 as compensation
- Reduces taxable income by $10,000
Executive:
- Receives $10,000 bonus (taxable)
- Owns $500,000 policy
- Pays income tax on $10,000 bonus
Employer:
- Deductible: Premium payments deductible as compensation
- Reasonable compensation: Must be reasonable amount
Executive:
- Taxable income: Bonus (premium) is taxable compensation
- Owns policy: All policy rights and benefits
- Death benefit: Tax-free to executive's beneficiaries
For employer:
- Tax deduction: Unlike key person insurance
- Selective: Can choose which executives
- Simple: Easy to implement
- Golden handcuffs: Encourages retention
For executive:
- Policy ownership: Executive owns valuable asset
- Personal benefit: Coverage continues after employment
- Portable: Can take with them if leave
- Tax-free benefit: Death benefit to family tax-free
Protect employer investment:
Golden handcuffs - executive must stay:
Year 1-2: 0% vested
Year 3: 25% vested
Year 4: 50% vested
Year 5: 75% vested
Year 6+: 100% vested
If executive leaves before fully vested:
Employer gets back portion of cash value
Share costs and benefits between employer and employee.
Employer and employee split:
- Premium payments: According to agreement
- Policy benefits: Death benefit and cash value
- Cash value: Employer recovers premiums paid
Endorsement split-dollar:
- Employer owns: Employer owns policy
- Employee has rights: Endorsed rights to portion of death benefit
Collateral assignment:
- Employee owns: Employee owns policy
- Employer has lien: Collateral assignment for premiums paid
Complex taxation:
- Economic benefit: Employee taxed on value of life insurance protection
- Loan regime: Or structured as loan with interest
- IRS scrutiny: Subject to detailed IRS rules
Informally funded with life insurance:
- Employer promise: Promise to pay benefits in future
- Life insurance asset: Employer-owned policy on executive
- Not qualified plan: Not subject to ERISA
- Selective: Only for key executives
Example:
Employer promises: $50,000/year for 20 years at retirement
Employer buys: $1 million policy on executive
At retirement: Employer pays from general assets
Life insurance: Helps employer fund obligation
Death benefit only (DBO):
- Benefit to survivors: Pays salary continuation to family
- Employer obligation: Promise to pay if executive dies
- Funded by insurance: Employer-owned life insurance
- Tax deduction: Employer deducts when paid
Protect partners:
- Partner's agreement: Each partner insures the others
- Business continuity: Provides cash for buyout
- Insurable interest: Partners have insurable interest in each other
- Premiums: Not deductible
- Death benefits: Income tax-free
Life insurance serves many important business purposes beyond personal protection. Business owners use life insurance for key person protection, business succession, executive benefits, and employee retention.
Protect business from financial loss due to death of key employee.
Essential to business success:
- Owner/founder: Creator of business
- Top executive: CEO, CFO, COO
- Key salesperson: Major revenue generator
- Specialized expert: Unique knowledge or skills
- Important relationship: Key client relationships
Test: Would the business suffer significant financial loss if this person died?
Structure:
1. Business is owner: Company owns policy
2. Business is beneficiary: Company receives death benefit
3. Business pays premiums: Company pays all premiums
4. Insured is key person: Policy on key employee's life
Example:
Key person: Founder/CEO
Policy owner: ABC Corporation
Insured: Founder
Beneficiary: ABC Corporation
Face amount: $2 million
Premium payer: ABC Corporation
When key person dies, business uses proceeds to:
- Maintain operations: Cover revenue loss during transition
- Recruit replacement: Pay search firm, relocation, signing bonus
- Train new person: Time and cost to get up to speed
- Pay debts: Meet obligations if credit affected
- Reassure lenders: Demonstrate financial stability
- Retain employees: Prevent exodus due to uncertainty
- Buy out deceased's interest: If also owner
Methods:
Multiple of salary:
Annual compensation: $200,000
Multiple: 5-10 times
Coverage: $1,000,000 - $2,000,000
Contribution to profits:
Key person generates: $500,000 annual profit
Years to replace: 3-5 years
Coverage: $1,500,000 - $2,500,000
Business valuation impact:
Business value with key person: $10 million
Value without key person: $6 million
Loss: $4 million
Coverage needed: $4 million
Premiums:
- Not tax-deductible: Business cannot deduct premiums
- Business expense: But not deductible expense
Death benefits:
- Income tax-free: Death benefit not subject to income tax
- Increases net worth: Adds to business value
Cash value:
- Asset of business: Shows on balance sheet
- Tax-deferred growth: Increases without current taxation
Example:
Annual premium: $20,000
Paid by: ABC Corp
Tax deduction: $0 (not deductible)
Death benefit received: $2,000,000
Income tax: $0 (tax-free)
Available for: Business use
Ensure orderly business transfer when owner dies, retires, or becomes disabled.
Owner dies:
- Heirs own business: But don't work in business
- Surviving owners stuck: Can't get rid of inactive owners
- Heirs want money: But business has no cash
- Forced sale: May have to sell at discount
- Disputes: Disagreements over value, control
Legal contract requiring:
1. Obligation to sell: Deceased owner's interest must be sold
2. Obligation to buy: Survivors must buy the interest
3. Pre-determined price: Formula for valuation
4. Funding mechanism: Life insurance provides cash
Owners buy from each other:
Structure:
- Each owner buys policy: On each other owner
- Owners are beneficiaries: Of policies on others
- When owner dies: Survivors use proceeds to buy deceased's interest
Example - 3 Partners:
Partner A owns policies on B and C
Partner B owns policies on A and C
Partner C owns policies on A and B
Total policies: 6 policies (each partner on each other)
Partner A dies:
B and C receive death benefits from their policies on A
B and C use proceeds to buy A's interest from estate
B and C now own 50% each (2-way split)
Advantages:
- Step-up in basis: Surviving owners get stepped-up basis in purchased interest
- Personal ownership: Owners control their own policies
- Tax-free benefit: Death benefits income tax-free
Disadvantages:
- Multiple policies: n × (n-1) policies needed [3 owners = 6 policies]
- Premium disparity: Older/less healthy owners pay more
- Complexity: More policies to manage
- Age differences: Premiums vary significantly
Basis step-up example:
Partner A's original basis: $100,000
Purchase price paid: $500,000
New basis for B and C: $600,000 ($100,000 + $500,000)
Benefit: Higher basis reduces future capital gains tax
Business buys from deceased owner's estate:
Structure:
- Business owns policies: On each owner
- Business is beneficiary: Receives death benefits
- Business buys interest: Redeems deceased owner's shares
Example - 3 Partners:
ABC Corp owns policy on Partner A
ABC Corp owns policy on Partner B
ABC Corp owns policy on Partner C
Total policies: 3 policies
Partner A dies:
ABC Corp receives death benefit
ABC Corp buys A's interest from estate
B and C ownership increases proportionally (now 50% each)
Advantages:
- Fewer policies: Only n policies needed [3 owners = 3 policies]
- Equal premiums: Business pays all, owners share cost equally
- Simplicity: Easier to administer
- One buyer: Business is sole purchaser
Disadvantages:
- No basis step-up: Surviving owners don't get increased basis
- Corporate funds: Uses corporate money
- Accumulated earnings: May face accumulated earnings tax
- Alternative Minimum Tax: May trigger AMT issues
Flexibility:
- Decide later: Determine at death whether cross-purchase or entity
- Tax planning: Choose most favorable structure
- Best of both: Combines advantages
Agreement must specify how to value business:
Fixed dollar amount:
Business worth: $3 million (agreed value)
Update annually: Review and adjust
Problem: Often not updated regularly
Formula approach:
Book value: Net assets value
Capitalized earnings: Earnings × multiple
Revenue multiple: Revenue × industry multiple
Appraisal:
Independent appraiser determines value at death
Most accurate but expensive
Example:
3 equal partners
Business value: $3 million
Each partner's share: $1 million
Insurance on each partner: $1 million
Partner A dies:
Estate receives: $1 million for A's 1/3 interest
Survivors get: A's interest
New ownership: B and C each own 50%
Life insurance ideal because:
- Creates instant cash: Death benefit available immediately
- Income tax-free: Proceeds not subject to income tax
- Guaranteed funding: Amount certain at death
- No liquidation: Don't have to sell business assets
- Estate liquidity: Heirs get cash, not illiquid business interest
Separate agreement for disability:
- Disability income insurance: Provides funds to buy out disabled owner
- Waiting period: Typically 12-24 months
- Buyout over time: Often structured as payments over 2-5 years
Reward and retain key executives with life insurance.
Structure:
1. Employer pays premium: On policy for executive
2. Executive owns policy: Executive is owner and beneficiary
3. Premium is bonus: Taxable compensation to executive
4. Employer deducts: Employer deducts premium as compensation
Example:
Executive compensation: $200,000
Bonus (premium): $10,000
Total taxable income: $210,000
Employer:
- Pays $10,000 premium
- Deducts $10,000 as compensation
- Reduces taxable income by $10,000
Executive:
- Receives $10,000 bonus (taxable)
- Owns $500,000 policy
- Pays income tax on $10,000 bonus
Employer:
- Deductible: Premium payments deductible as compensation
- Reasonable compensation: Must be reasonable amount
Executive:
- Taxable income: Bonus (premium) is taxable compensation
- Owns policy: All policy rights and benefits
- Death benefit: Tax-free to executive's beneficiaries
For employer:
- Tax deduction: Unlike key person insurance
- Selective: Can choose which executives
- Simple: Easy to implement
- Golden handcuffs: Encourages retention
For executive:
- Policy ownership: Executive owns valuable asset
- Personal benefit: Coverage continues after employment
- Portable: Can take with them if leave
- Tax-free benefit: Death benefit to family tax-free
Protect employer investment:
Golden handcuffs - executive must stay:
Year 1-2: 0% vested
Year 3: 25% vested
Year 4: 50% vested
Year 5: 75% vested
Year 6+: 100% vested
If executive leaves before fully vested:
Employer gets back portion of cash value
Share costs and benefits between employer and employee.
Employer and employee split:
- Premium payments: According to agreement
- Policy benefits: Death benefit and cash value
- Cash value: Employer recovers premiums paid
Endorsement split-dollar:
- Employer owns: Employer owns policy
- Employee has rights: Endorsed rights to portion of death benefit
Collateral assignment:
- Employee owns: Employee owns policy
- Employer has lien: Collateral assignment for premiums paid
Complex taxation:
- Economic benefit: Employee taxed on value of life insurance protection
- Loan regime: Or structured as loan with interest
- IRS scrutiny: Subject to detailed IRS rules
Informally funded with life insurance:
- Employer promise: Promise to pay benefits in future
- Life insurance asset: Employer-owned policy on executive
- Not qualified plan: Not subject to ERISA
- Selective: Only for key executives
Example:
Employer promises: $50,000/year for 20 years at retirement
Employer buys: $1 million policy on executive
At retirement: Employer pays from general assets
Life insurance: Helps employer fund obligation
Death benefit only (DBO):
- Benefit to survivors: Pays salary continuation to family
- Employer obligation: Promise to pay if executive dies
- Funded by insurance: Employer-owned life insurance
- Tax deduction: Employer deducts when paid
Protect partners:
- Partner's agreement: Each partner insures the others
- Business continuity: Provides cash for buyout
- Insurable interest: Partners have insurable interest in each other
- Premiums: Not deductible
- Death benefits: Income tax-free