Buying life insurance for your company is not simple. Many business owners make common mistakes during the process. This article highlights 10 important mistakes to avoid when buying life insurance for your company, helping you make the right decisions for your business’s future.
While not as exciting as high-stakes proposals or tight project deadlines, this task is essential for every responsible business owner.
1. Believing personal life insurance policy will also provide coverage for their business.
If you have a life insurance policy to protect your family, it may not cover your business if you die, especially if there are multiple owners.
To protect your business in case of your or your partner’s death, you should have a buy-sell agreement. This agreement, backed by life insurance, specifies how the business assets and shares will be distributed among the remaining owners.
In the case of an owner’s death in your company, a buy-sell agreement allows for tax-free funds to support the remaining owners and maintain business operations. This provision prevents the need to sell assets or dissolve the business to acquire the deceased owner’s share from their family.
In essence, a buy-sell agreement ensures a seamless sale of a business after the owner passes away, preventing any involvement from the owner’s family. This arrangement ensures that the deceased owner’s family receives compensation while allowing the business to continue and progress without disruption.
Cross-Purchase Agreement
A cross-purchase agreement is a document that enables a company’s partners or shareholders to buy the shares of a partner who has passed away, become incapacitated, or retired. It is used as part of business continuation planning and specifies how the shares will be divided or purchased by the remaining partners, usually based on their ownership stakes in the company.
– Investopedia
Differentiating between the two things.
In a cross-purchase agreement, owners buy life insurance policies on each other, leading to a lot of paperwork when there are three or more owners involved. On the other hand, in a stock redemption plan, the business itself is the owner and beneficiary of the policies. This plan works best for businesses with more than two owners.
3. Not Considering the Importance of Key Person Insurance
Key person insurance is a type of life insurance that covers important employees or partners whose absence would greatly affect a company’s success. Neglecting to identify and ensure these key individuals can put your business in jeopardy. When buying life insurance for your company, be sure to evaluate those who are crucial to its operations and consider getting key person insurance as part of your overall coverage.
Key person insurance protects your business by providing:
- The company’s financial loss was due to the unexpected death of an employee with unique expertise.
- The amount of time and resources required for interviewing potential replacements.
- The amount of time and resources required to hire and train the selected replacement.
- Potential clients may be lost during this period of change.
4. One common mistake people make is buying the wrong insurance policy.
Many business owners choose the inappropriate buy-sell agreement or opt for a very short-term life insurance policy.
Viewing life insurance for your business as just a checkbox is a mistake. Understand its significance and the level of protection it offers. Treat it like other important business decisions. Conduct thorough research, ask questions, and weigh your options carefully.
5. When you don’t purchase enough coverage.
Before completing a cross-purchase agreement or stock redemption plan, make sure the total coverage aligns (with some room for growth) with your business’s value, calculated using one of the provided formulas.
- Book value: It is an important measure used in determining the net worth of a business.
- Net worth.
- Market value: Market value can fluctuate over time as market conditions change and as perceptions and valuations evolve.
- The price a buyer is willing to pay for a business, usually determined by comparing with similar businesses.
- Capitalization of earnings: It is a method used by investors and financial analysts to evaluate businesses and determine their investment attractiveness.
Current annual earnings and predicted future earnings
When Book Value and Market Value don’t match, the decision usually favors Market Value. This is because Market Value is generally higher and reduces the risk of being inadequately insured.
Key person life insurance amount is determined by multiplying the estimated number of years your business would struggle without the key person by their total annual compensation.
Life insurance companies usually offer coverage for key personnel up to 10-15 times their total compensation, including bonuses. For most businesses, insuring the key person’s compensation for 5-10 years is both adequate and affordable. In case of compensation fluctuations, calculate the average from the past three years.
When it comes to getting a loan from the Small Business Administration (SBA), it is important to not wait until the last minute to submit your application. This can cause unnecessary stress and increase the chances of missing the deadline.
6. Cutting an SBA Loan Deadline Too Close
Life insurance can take about 8 weeks to complete from the first call to approval. If you wait until the last minute to apply, you may have to get a more expensive non-medical policy instead of one with a medical exam.
You can save a lot of money by getting a medical exam and starting your life insurance shopping early. We can change your non-medical policy for a cheaper option later on.
If you already have sufficient life insurance for your family, you might think about getting a policy that lets you reduce the coverage amount as your loan is paid off.
Before you claim life insurance payments as business expenses, it’s wise to seek advice from your CPA or tax adviser. While it’s possible to categorize insurance premiums as expenses, this may result in the insurance proceeds becoming taxable. This can lead to a lower amount of money received by your business.
8. Forgetting to Revisit Policies Annually
As your company grows and changes, it’s important to reassess your life insurance policies annually. This ensures they still provide sufficient coverage for your business. Neglecting this could result in being underinsured or paying for unnecessary coverage.
9. Skipping intermediaries and directly approaching a major insurance company.
While it may seem convenient to choose a well-known insurance company for your business life insurance, they often lack expertise in home and auto insurance, which is different from life insurance.
- Major insurance companies such as State Farm and Allstate allocate nearly a billion dollars annually towards advertising, causing these expenses to be ultimately borne by the consumers. Furthermore, their agents are “captive,” limiting their ability to offer life insurance policies solely from their respective companies.
10. Not Involving Legal and Financial Advisors
Finally, one of the biggest mistakes to avoid when purchasing life insurance for your company is trying to do it all on your own. Involving legal and financial advisors who specialize in business insurance can help you navigate complex policies, legal implications, and tax considerations. Their expertise will ensure that your decisions are well-informed and align with your company’s long-term goals.
Getting life insurance for your company is a crucial choice that requires careful consideration. To protect your business and ensure its lasting success, avoid these 10 common mistakes and seek expert advice. Take the necessary time to evaluate your company’s requirements, explore different options, and make informed decisions that will safeguard your business and its future.