The Winnipeg Free Press
Business, Friday, May 25, 2007, p. b5

Death can affect entire business

Dollars and Sense / David Christianson

Last week, we talked about how to calculate life insurance needs for a family breadwinner. Have you done your calculation?

Today we will discuss some of the circumstances that give rise to a life insurance need in a business situation. (Next week, barring something particularly exciting happening in the world of money, we will explore the different types of permanent life insurance.)

Many businesses involve more than one owner. In this situation, Step 1 is to have a buy-sell agreement. This outlines how the business would be valuated and how the company would pay out a partner or shareholder's estate if that person died.

Step 2 is making sure such an agreement can be carried out, by making sure the required funding will be in place if one partner dies. Funding such an agreement with life insurance makes it much more practical, as there is usually not enough cash kicking around in the company to buy back a significant amount of shares if someone died. Since the chance of someone dying is small and the dollars are generally needed in the business, it would be very inefficient to bank the kind of money needed in a reserve fund and not be able to put it to use.

As well, relatively new companies have not had the time to put such reserves away. Finally, there are distinct tax disadvantages to funding a buy-sell agreement with retained earnings.

A life insurance company accepts this relatively small risk for a relatively small amount of money, which is a great arrangement.

Funded buy-sell agreements also give much more security to the families of the partners and shareholders, who know they will realize their share value in cash quite quickly, rather than wait a number of years for the company or the surviving partners to come up with the money.

As well, life insurance paid out in this manner pays the value out tax free, if arranged properly.

To calculate the need, start out by asking yourself how much money it would take someone to buy your share of the business. If that's the value you would want your family to receive for their shares if you died, think about having the company purchase that amount of life insurance on your life. Do the same for your partners, and think carefully about what your shares will be worth in five or 10 years. That may be the amount of insurance you want to put in place now.

The second broad type of need that all businesses should look at is "key-person" insurance, which is coverage on an important executive, manager, inventor, salesperson or other employee. Ask yourself the question, "Where would the business be if that person died?"

If the answer is "up the creek" to any extent, then put the right amount of life insurance on that person's life. The dollars could be used to find a replacement, to provide lost income during the interim or to reassure the bank everything will be fine and the line of credit shouldn't be pulled.

There are more elaborate strategies using life insurance to help remove years of built-up retained earnings from a company without paying tax, to provide tax-advantaged retirement savings for executives or owners and, of course, as protection for employees and their families.

If you are a business owner, large or small, you should explore these opportunities with an insurance professional. (Then, you should get a sober second opinion from your lawyer, accountant or a fee-for-service financial adviser like me. Occasionally, insurance people can get very excited about their strategies and products.)

Having said that, be open and realistic about your need for insurance and the opportunities that are presented by life insurance products.

Remember, insurance is not a religion. I always laugh when I hear people say, "I don't believe in insurance." I don't believe in dying either, but I'm reasonably certain it will happen.

David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc. His column appears Fridays. You can e-mail him at dchristianson@wellwest.ca.

Category: Economy
Uniform subject(s): Insurance
Length: Medium, 546 words

© 2007 Winnipeg Free Press. All rights reserved.

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