A life insurance policy is a contract with an insurance company. In exchange for premium payments, the insurance company offers a lump – sum payment, known as a death benefit, to beneficiaries upon the insured’s death. As a small business owner, someone is depending on you financially.
Maybe it is a team of employees, customers with contracts, or vendors with invoices to be paid. Employees, customers, even your vendors depend on your payments to cover their expenses. If something happens to you, that is a lot of people left in the open.
Typically, life insurance provides a financial safety net in the event of death, removing some of the worry so you can focus on day – to – day issues. Life insurance is also necessary if you use a house or other personal assets as collateral for a business loan. Imagine a grief – stricken spouse scrambling to pay off the debt to avoid losing the home.
Note that liquidating the business to pay lenders may not always be an option. The business might not be worth so much without the owner at the helm. Or heirs might have to unload it at a discount when forced to sell the business quickly.
Life insurance has also been used as machinery by business owners to treat their adult children fairly when not all of them are part of the business. A parent, for instance, plans to leave the business to the daughter and wants to give an equal inheritance to a son. A life insurance policy can help do that.
Also imagine losing a hard – to – replace employee. Irrespective of how hard everyone else worked to keep things going, the business would in some aspects lose revenue while the team scrambled to regroup. Life insurance can provide your business with working capital to get it through.
Permanent life insurance can even be used as additional compensation to key employees, enticing them to stick around. Normally, a business buys a permanent life insurance for the employee. Even though the business pays the premiums, the employee remains the owner of the policy and later can use the cash value to supplement retirement income.
In a “split – dollar” life insurance arrangement, the business and the employee share the costs, death benefit and cash value of the policy. The type and amount of life insurance to get will depend on your goals for the policy. Howbeit, there are many varieties of life insurance, and they serve a variety of needs for a business. Some of the common types include;
3 Types of Compulsory Life Insurance for Small Business Owners
1. Term life insurance
Term life insurance is designed to offer financial protection for a specific period of time, such as 10 years. Note that with a traditional term insurance, the premium payment amount will stay the same for the coverage period you choose.
However, after that period, policies may offer continued coverage, maybe at a substantially higher premium payment rate. Term life insurance is generally less expensive than permanent life insurance. In addition, note that Term life insurance proceeds can be used to replace lost potential income during working years.
This can serve as a safety net for your beneficiaries and can also serve as an avenue to ensure the family’s financial goals will still be met—goals like paying off a mortgage, keeping a business running, and paying for college. Also have it in mind that although term life can be used to replace lost potential income, life insurance benefits are paid at one time in a lump sum, not in regular payments like pay checks.
- Typically, the term will be in 10 – year increments, so you will most often buy a 10 – year, a 20 – year, or a 30 – year policy.
- If you buy a level term policy, the premiums and the death benefit remain constant for that term.
- Under a decreasing term policy, your premiums and your death benefit will decrease over time.
- With an annual renewable term policy, your policy renews automatically each year at a new price point, but the death benefit remains the same.
2. Universal life insurance
Universal life insurance is a type of whole life insurance designed to provide lifetime coverage. But unlike whole life insurance, universal life insurance policies tend to be more flexible and may even allow you to raise or reduce your premium payment or coverage amounts throughout your lifetime. Owing to its lifetime coverage, universal life typically has higher premium payments than term.
In the United States, universal life insurance is most often used as part of a flexible estate planning strategy to help preserve wealth to be transferred to beneficiaries. Another example of long term income replacement is when the need extends beyond working years. Some universal life insurance product designs focus on offering both death benefit coverage and building cash value while others focus on providing guaranteed death benefit coverage.
3. Whole life insurance
Whole life insurance is a type of permanent life insurance designed to provide lifetime coverage. Owing to the lifetime coverage period, whole life insurance tends to have higher premium payments than term life. Policy premium payments are typically fixed, but, unlike term, whole life has a cash value, which serves as a savings component and may accumulate tax – deferred over time.
This type of life insurance can be used as an estate planning tool to help preserve the wealth you plan to transfer to your beneficiaries. If you buy a whole life insurance, the insurance company will want the death benefit to equal the cash value (the amount of money in excess of the policy fees) by the time you turn 100 or 120 years old.
So if you start off at age 20, your premiums may not be very much. If you start off at age 80, you will only have 20 years to accumulate $1 million in coverage in cash value.
It means that you are going to have extremely high premiums, and the reason the insurance companies build it that way is for stability. Howbeit, the older you get, the more likely you are going to die, and insurance companies want the money you’ve invested with them to cover your death benefit.
- An index life policy leverages a whole life chassis, and the policy will have a cash value. However, that cash value’s going to be tied to, or benched by the growth of an equity index like the S&P 500, the Russell 1000, and the MCSI Index. Even though you cannot invest directly into an index, the insurance companies will provide the indexes which fit their pricing model.
- A variable life policy also uses a whole life chassis, but the insurance company does not control the cash value of the policy. Instead, you invest (you have to have a securities license to deal with this) the cash value of the policy into separately managed accounts (also called sub – accounts). However, it can invest your cash value directly into the stock market. If the market goes up, then your cash value will increase at market rates less the fees of the separately managed account.
- A second – to – die life policy can help older individuals who are trying to do some estate planning. This policy pays after the second person of a couple dies, and it works well to equalize your estate among your children.
Life insurance for business owners fills a variety of needs. Your rate class is determined by a number of factors, including overall health, family medical history and your lifestyle. Tobacco use, for example, would increase risk and, therefore cause your premium payment to be higher than that of someone who doesn’t use tobacco.