Background: A long-time business client had not updated their business’ value in a few years, so when they decided to make the necessary updates, the value had significantly increased. While this is a great problem to have, it does create additional issues in the entire business plan; specifically in this case relative to insurance coverages.
Our Case: Alice and Beth own a company along with their mother. They each own 40% and Mom owns 20%. Eventually they will inherit Mom’s shares equally, and at this time, they are handling most of the company’s operations. When we originally started business planning, the company value was just over $2 million. At that time, Alice and Beth, both well under 30 then, did not have significant assets built up outside the business. They did have a buy-sell agreement in place stating that should a partner pass away, the shares would purchased by the company and other share holders. In order to address this potential large cash flow need, Alice and Beth opted to purchase $1 million of term life insurance on each other. That way if the unexpected happened, they would not impact their personal financial picture as they would receive tax free death benefits to meet this cash need. Mom’s share was smaller and would ultimately pass to them anyway.
In addition to life insurance Alice and Beth acquired disability income insurance and disability buy-out insurance, which they purchased on each other. The disability income insurance was to protect their personal financial picture in case of a disability. The disability buy-out would provide them with a $400,000 lump-sum payment if the other were to be disabled. This once again protects their personal financial picture as they would only need to allocate the annual premium versus having to come up with the $400,000 upon the unexpected occurrence.
The Results: Now we fast forward about five years, and they have updated their business value. The new business value is at $5.3 million, which is quite a bit different than the prior value. Alice and Beth have also moved more into management roles and are less involved in hands-on daily activities. The increased business value created a much higher need for life insurance. While Alice and Beth have both grown their Net Worths outside of the business, neither wants to be forced to pay $2 million should the other pass away. New term life insurance policies were put in place, with each other owning the coverage on the other sister, to address this need. Both Alice and Beth are still young and healthy, so this annual cost is under $1,000 each. The new business value is also important for the disability buy-out coverage as now that the need is closer to over $2 million if Alice or Beth is disabled and needs to leave the business. Additional coverage was purchased for this too. With Alice and Beth doing more in management versus the daily hands-on work, we were able to decrease the cost for the disability income benefit and increase their coverage.
Bottom Line: Now Alice and Beth can continue to run their business without worry, knowing that if the unexpected happens, they will be financially prepared. They are well protected from the unexpected and their personal financial pictures can continue to grow.
This is a hypothetical example for illustrative purposes only. The experience of this client may not be representative of the experience of all clients and is not indicative of future results. Any tax advice contained herein is of a general nature and is not intended for public dissemination. Further, you should seek specific tax advice from your tax professional before pursuing any idea contemplated herein. This advice is being provided solely as an incidental service to our business as financial planner. Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Financial Planning and Investment Advisory Services offered through B & E Investment Advisers, Inc., a State Registered Investment Adviser, Business & Estate Advisers, Inc., B &E Investment Advisers, Inc. and B&E Pension Advisers, Inc are separate entities from Valmark Securities. (1) Names have been changed to protect the identity of the client.
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