We’ve heard the stories about the architect whose house plans are never completed or the attorney with no estate plan. Those of us who manage our own businesses often get tied up in the day-to-day activities and miss the big picture as it relates to long-term planning.
Planning for the long term could be the difference between a company being handed down to family or being forced to liquidate. It can allow for a smooth transition when one partner passes away. It can permit your company to continue to thrive with the loss of a key employee. It can even help your company retain the individuals you can’t afford to lose.
Two big questions in deciding to move forward with a business succession plan — a buy-sell agreement, a key-man plan, estate tax planning, or providing benefits — are typically: Which tools will we use to accomplish our goals? And, how will we pay for it?
A major portion of business planning can be accomplished with the use of life insurance. Even the largest companies don’t typically have $25 million, $50 million, or even $100 million to use as cash flow for things like estate taxes. Life insurance can be a tool to leverage our business planning.
The next question is: How are we going to pay for the life insurance?
Normally, when we think of life insurance, writing monthly or annual premium checks comes to mind. While this is one of the most common ways to pay premiums, it certainly isn’t the only way to plan.
As business people, we’re accustomed to finding ways to use other people’s money to build and grow our business — why not use this same strategy to pay for planning to protect our business? And more importantly, how does this work?
Currently, I’m working with a business in Virginia needing $25 million of life insurance to accomplish their succession planning. The annual cost of this insurance would be approximately $390,000. This option would work, but it could, potentially, put a bit of a strain on the company’s cash flow.
Another option for this company would be utilizing a collateralized life insurance policy.
With collateralized life insurance, the premiums are loaned to the policy by a bank. Properly structured policies have very low costs and, typically, a cash value close, or equal, to the loan value in the first year. Lenders who specialize in this type of planning only require collateral to be posted.
The collateral needed for this company would last close to nine years, and the maximum expected collateral is $1.3 million. The collateral need diminishes when there is an arbitrage of interest earned in the policy versus the interest being charged on the loan.
Life insurance can also be a source of tax-free accumulation of cash value and, potentially, tax-free income.
Business owners wanting to provide income replacement in retirement or benefits to retain employees might find this beneficial. The employer controls the life insurance policy until the employee satisfies an agreed-upon contact period.
This can put “golden handcuffs” on that employee. It can also create a culture of loyalty for your company, as many employees will have more income in retirement than while they are working.
I recently met with a company of 600 employees; the employer identified 50 employees vital to the success of the company. By using collateralized life insurance, they will be able to provide a retirement benefit to each of these employees, exceeding their current income with no out-of-pocket cash flow from the employer. The string attached, however, is that the company will need to post collateral between eight and 10 years.
Collateral can be met primarily with an investment account, cash reserves, or through a bank letter of credit. This can be a drawback for some companies, but it can be a great opportunity for leveraged benefits for many others.
I meet with businesses every week that haven’t done any long-term planning or have only covered a portion of their true need. Using a properly structured leveraging strategy may be critical to the long-term success of your business.