BUSINESS INSURANCE

Key Person Insurance

Business owners and other key executives spend considerable time and effort to acquire the knowledge, experience, judgement, reputation, relationships and skills that make them valuable to the business. When they die, the business loses a key member of the management team and this can have a severe financial impact.

During the disruption that follows the death of a key player, lenders may cut back credit, creditors may press for immediate payment, debtors may delay making payments, employees and customers may lose confidence, and competitors make take advantage of the situation. Larger corporations are often in a much better position to prepare for key executive turnover because of sheer size and numbers. For smaller businesses finding an immediate replacement with the same qualifications as the deceased owner or executive is much more difficult. In the absence of proper planning, the very survival of the business may be affected by the death of a business owner or a key executive.

The impact of this situation can be considerably reduced if the business has purchased an insurance policy on the life of the owner and/or key executive. If they die, the life insurance proceeds give the business working capital to meet immediate cash needs and provide a source of funds for finding, attracting, hiring and training a replacement for the deceased executive, or to hire interim management.

Business Loan Protection

It can be difficult to obtain adequate debt financing for a small business. Creditors will often require the business owner to personally guarantee a loan. The death of the business owner or another key executive may cause creditors to demand immediate repayment of outstanding business debts. This can place a significant burden on the business and force the liquidation of key business assets at fire sale prices at a time when business results may already be severely impacted by the death. In addition, if the business owner has personally guaranteed the debts incurred by the business, the owner, or the owner's estate may be liable for any outstanding debts that the business is unable to pay.

A solution is for the business to buy an insurance policy on the life of the business owner(s) or other key executives. Proceeds from the life insurance policy are tax-free and may be used to pay down the outstanding business debt. A creditor may require a small business to purchase collateral life insurance to protect the creditor's interests, particularly if the death of the business owner could affect the value of business assets used to secure the debt. In other cases, the business owner may simply want to ensure that business debts will be fully repaid if he or she dies to minimize financial risks for heirs and to permit the business to continue free of debt.

Generally, life insurance premiums paid for business loan protection are not deductible for tax purposes. However, if a life insurance policy has been collaterally assigned to a restricted financial institution, a portion of the premiums may be deductible.

Buy-sell Funding

A key component of an integrated financial plan is planning for business succession. An integral part of any succession plan is to ensure that financing is in place to fund the purchase and sale of the business interest if an owner dies. Life insurance is generally an efficient way to fund the obligation that results from a buy-sell agreement when a shareholder or partner dies. An important consideration is whether to fund the buy-sell arrangement with corporate owned or personally owned life insurance. Ensuring that the ownership is properly arranged from the onset will avoid a transfer of ownership of the insurance policy in the future, which would result in a disposition of the policy and could possibly trigger a tax liability.

Funding Capital Gains Tax on a Business at Death

An individual who owns shares in a corporation, a partnership interest, or business assets (as in the case of a sole proprietorship) will be deemed to have disposed of these properties at death. As a result a tax liability may arise in the form of capital gains and recaptured capital cost allowance. If funds or other assets are not available to pay the tax liability, the shares or partnership interest may have to be sold, or business assets may have to be liquidated, possibly for a price below the fair market value. Life insurance can provide the funds needed to pay the tax liability that results from the capital gains and recaptured depreciation triggered by an individual's death. The individual could own the life insurance policy, or it could be owned by the corporation or partnership and dispersed to the individual's estate after death.

Split Dollar Life Insurance

Life insurance's versatility makes it an excellent choice for meeting a dual need experienced by many small businesses. It's common for one party within a business to need the financial protection that life insurance provides against death, either their or someone else's within the company, while another person needs a tax-sheltered investment vehicle. In these arrangements, one party typically owns and pays for a level death benefit portion of the policy and the other party owns and funds the remaining interests in the policy (generally the cash value).

Executive Compensation

Small business owners often offer supplementary benefit packages to attract executives. These packages offer a wide assortment of benefits, which may include life insurance protection. The policy may be purchased by the business/employer, or it may be owned and funded jointly by the employer and the executive. The executive's dependants would be named as the beneficiary of all or a portion of the policy. The employer paid portion of the life insurance premium must be reported as a taxable benefit to the executive. It is important that the amount reported represents a reasonable cost for the benefit received.

Wealth Creation

​Often a business's profits or surplus cash are invested in GICs or taxable investments. These taxable investments may not be the business's best investment option. If the business already needs an exempt life insurance policy for key-person insurance, business loan protection or some other business insurance need, the policy could also be used as a vehicle for investing the company's excess profits. An exempt, permanent life insurance policy allows for tax-deferred growth of the cash value and tax-free receipt of the proceeds at death. The cash value growth within an exempt policy is not subject to annual accrual taxation and is only subject to tax if there is a disposition of the policy. Significant cash value can accumulate on a tax-deferred basis if the business deposits the maximum amount permitted by the Income Tax Act into the exempt policy. The deposits can remain within the policy on a tax-sheltered basis and pay for the cost of insurance and expenses in future years. If the corporation or shareholder needs access to the cash, the policy's cash surrender value can be accessed through withdrawals or a collateral loan secured against the insurance policy.