How Insurance Can Benefit Your Business

Using Insurance for Business Continuation

Key person insurance provides protection through life insurance in the event of the loss of a key employee. The business is the beneficiary of the policy, and the death benefit may be received tax-free. These funds can help recruit, hire and train a replacement for the deceased employee, as well as offset lost cash flow and replace lost profits. This kind of insurance can also help reassure creditors and customers that your organization has a plan for business continuity. However, the premiums aren’t tax-deductible, and the life insurance owned by C corporations may be subject to alternative minimum tax.

Cross-purchase buy/sell insurance allows business co-owners to purchase life insurance policies on each other. When one owner dies, the other living owners can use the proceeds from the policy to buy out the deceased owner’s share of the business. This provides for an orderly buy-out of business interest, with selling price, terms and future ownership determined by a buy/sell agreement. It offers guaranteed financing, and allows for an increase in cost basis for surviving owners in the amount paid for the deceased owner’s share. However, the number of policies can be cumbersome when multiple partners are involved, and the premiums are not tax-deductible.

Entity purchase buy/sell insurance provides liquidity for businesses to buy out a deceased owner’s business interest, with selling price, terms and future ownership determined by an agreement. It offers guaranteed cash financing and requires fewer policies than cross purchase buy/sell insurance. The beneficiary of the policy is the business, and the death benefit may be received income tax-free. However, there is no increase in cost basis for surviving owners and any life insurance owned by a C corporation may be subject to alternative minimum tax. In addition, the premiums are not tax-deductible.

Using Insurance to Benefit Executives and Key Employees

Executive bonus plans (also known as Section 162) offer additional death and retirement benefits through life insurance for selected employees, business owners and beneficiaries. It allows your business to add “golden handcuffs” through the use of contract endorsement. With an executive bonus plan, the company provides the key executive with a bonus, which is taxable as income to the employee but is a deductible expense for the company. The executive then uses the bonus to purchase a whole life or universal life insurance policy that builds cash value that grows tax deferred. This plan can offer tax benefits to your business, while allowing you to attract and retain key personnel.

Split-dollar endorsement method provides valuable life insurance protection for selected key employees by sharing the costs and benefits of the plan. By agreement, the life insurance benefits are split between the beneficiary and the business, and the death benefits may be tax-free for beneficiaries and business. This is a simple, flexible and low- or no-cost way to provide insurance for a key employee and offer additional retirement benefits. What’s more, the business recovers the cost of the premiums from the death benefit. However, the premiums are not tax-deductible, and this may not be an economical option for older employees.

Deferred compensation plans, such as Supplemental Executive Retirement Plans, allow highly compensated employees to contribute to a retirement plan in amounts that exceed the limits of a 401(k). In a deferred compensation plan, the employee defers a portion of their compensation, which grows tax-deferred in an investment account and is distributed at a later date (typically in retirement). These plans are often funded with a life insurance policy taken out by the employer on the employee: The employer pays the premiums and funds the plan with either the cash value or the death benefit. The death benefit may be tax-free to the employer, and the plan can be cost-neutral over time when it is properly designed. However, the employer deduction is delayed until the benefits are paid, and the benefits provided are subject to a continuation of the business. It’s important to note that some of the risk inherent with these plans can be mitigated by setting up an irrevocable employee trust, sometimes referred to as a rabbi trust. However, a rabbi trust is subject to claims of the employer's general creditors.

Salary continuation provides supplemental retirement benefits for selected key employees. As in deferred compensation, these plans can be financed with corporate-owned life insurance, with the business as the beneficiary of the policy. This can offer a simple way to recover costs if the plan is properly set up. However, the employer deduction is delayed until the benefits are paid out and those benefits are subject to the continuation of the business.