How to Use Your Life Insurance Policy to Invest in Your Business
- Life insurance is a tool, not a one size fits all solution.
- The cash value of a life insurance policy is a dynamic tool available to business owners.
- Life insurance policies can help with estate planning, tax planning, and talent retention.
As a business owner, you’ve got a lot on your mind. Your business's day-to-day operations and growth take up much of your time. Unfortunately, that leaves little time to focus on your company's future after your death.
A life insurance policy is one way to handle these issues once without focusing on them much in the future. Beyond that, there are many benefits to using a life insurance policy in a business, but first, you must be aware of some things.
Life Insurance is a Tool
Like any financial concept, there is no one size fits all. The investments you handle, your personal financial strategy, and company policies will determine the tools that should be used in your business. Likewise, life insurance has pros and cons, and it is vital to remember when purchasing life insurance for your business.
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Costs of Life insurance
Stating that life insurance has costs is a no-brainer, but it is often something life insurance salespeople glaze over. Instead, they focus on the payout, cash value, and tax benefit, which are all great, but you must also consider the costs.
Unlike a personal investment, a life insurance policy is issued by a life insurance company trying to make money. The goal is to put more money into the company than you take out. That means that the premium to maintain your life insurance will be hefty. Any investment done on your behalf is often laden with fees.
These are things to be aware of before using a life insurance policy. Once again, life insurance does a few things very well and makes a great addition to your tool belt, but it is not a one size fits all tool. So let’s look at how you can invest in your business with life insurance.
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Four Ways to Invest in Your Business With Life Insurance
Remember that throughout this article, we refer specifically to a whole life insurance policy, also known as permanent insurance. Term life insurance is helpful in a business as a benefit that you can offer to your employees, but the ability to invest in your business comes from a permanent insurance policy.
Borrow from the Cash Value
First, you can invest in your business with a life insurance policy by accessing the cash value. A term life insurance policy generally has no cash value because the payout is not guaranteed. But with a permanent life insurance policy, since you will be paid at some point, the insurance policy starts accumulating value that you can tap into.
Usually, tapping into the cash value of your life insurance policy takes the form of a loan or borrowing against the policy's value. Since the money is yours, you can get a loan against it pretty easily, which is ideal for businesses that need to solve a short-term liquidity problem or have other immediate money needs.
However, there are two things to remember when taking out a loan. Even though the money is yours, the insurance company isn’t let it slip through their fingers without adding interest. Second, this option isn’t immediately available to someone who takes out a permanent life insurance policy. Since the policy's cash value is your money, it will take some time for your money to increase in value since the insurance company covers its costs before adding significantly to your cash value.
Still, having access to a quick loan on hand can come in handy for a business owner.
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Protect your Business with Succession Planning
Life insurance policies can also help succession go smoothly in a business, especially one with partners or multiple heirs. For example, when all the partners in a business are still alive, they can set up a buy-sell agreement that states how much a partner would need to pay to buy out the other partner in the event of their death. This is great, except that the amount needed to buy out the deceased partner’s heirs is probably more than the living partner has on hand.
There are many potential ways around this, but one of the cleanest options is having a life insurance policy. If one partner dies, the life insurance policy kicks in and pays out to the heirs, and then it is business as usual.
Life insurance is a major investment in the business because probate, estate closing, arguing heirs, and so forth are great ways to destroy a business. By setting up a simple mechanism to pay off a partner’s heirs, the company can get right back into operating, allowing the business to keep growing.
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Reduce your Tax Burden
The more successful your business becomes, the more difficult it will be to find tax benefits to reduce your tax burden. As a business owner, you may be hitting the cap on contributions for ROTH IRAs or other retirement accounts. A life insurance policy is an option to get past that.
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With no income caps on who can contribute to a life insurance policy and life insurance payouts being tax-free, a life insurance policy can act like a ROTH IRA in many ways. This might not seem helpful since you have to “die to benefit,” but giving your heirs a tax-free lump sum is a huge benefit. Going the other way, investing in a life insurance policy on a tax-deferred basis is also possible, much like a regular IRA, meaning you won’t pay taxes on the gains until they are withdrawn.
These strategies are something to discuss with your CPA as you consider ways to use a life insurance policy to benefit your business.
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Offer Retention Bonuses to Talented Employees
Lastly, life insurance is a benefit you can offer to employees. Many people like the idea of having a life insurance policy but don’t want to pay for it. Offering life insurance or additional contributions to a life insurance policy incentivizes employees to stay at your company. If you can offer a larger policy than you are initially paying in, you can think of it as providing greater compensation to employees for pennies on the dollar.
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This depends on what your employees want and what will incentivize them to stay. But once again, this is another tool in your tool belt.
The Money Wrap-Up
Permanent life insurance policies have a lot of benefits that a business owner can tap into. The policy's cash value is one of the most practical ways to get a quick loan once you’ve built up the policy's value, and that should not be discounted. Reducing your tax burden on higher income is essential as a business becomes more profitable, and keeping talented employees will help a business grow faster than ever.
Business owners need to consider whether life insurance is a tool they should use to invest in their businesses.
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