Strategies
Strategies for Business
We work with companies, large and small, to recruit, retain and retire key people. Today, competition is fiercer than ever to find the best available talent. One way a company traditionally does this is to poach experienced key people from their competition. But a company can only offer so much money and benefits before it effects their bottom line.
Another reality is that these individuals get a mindset that they are hired guns. They will jump from one company to another for a little more money or another benefit. We have seen this in the tech world and in the trucking industry. For a company to thrive and grow beyond today, they need to manage their bottom line for tomorrow.
We can effectively help a company retain key people without increasing the costs typically associated with retention. We do this through the creative use of a life insurance policy that the company will finance through a major lender. Instead of the company shelling out huge premiums, they simply collateralize a loan. This arrangement is not typically reported in their filings or appears as a liability on their financial statement.
The key employee benefits several ways:
• They have a large life insurance policy that protects their family more than any increase in salary or bonus can. Whereas, increased income only pushes them into a higher tax bracket. Should they die from an accident or illness, the death benefit received is income and estate tax free.
• The insurance policy grows income tax-deferred. Unlike other investments or a 401k, the policy never suffers a market loss. The worst that can happen is that there is no-gain for that year. For example, in 2008, the S&P 500 Index lost almost 50%. It took seven years for it to recover. Conversely, our policyholders lost nothing that year.
• The key employee will be able to start receiving a six-figure, tax-free income stream for life, beginning as soon as the 15th year. No amount of earned income can do that.
• The beauty of this arrangement is that the employer can vest 100% of the policy over a period of time to be decided by the employer. In the business world, this is typically called a Golden Handcuff. It is a tool to keep the key employee onboard for a certain number of agreed upon years. If they leave, they forfeit the policy and its benefits. The policy and benefits revert to the company.
• All of this can be achieved with little money out of pocket. Thus, making this an excellent vehicle to retain key people.
Buy/Sell
A term life insurance policy provides a low-cost funding method for partners in a business or medical practice. Attorneys strongly suggest that partners have a
Buy/Sell agreement in place for several reasons:
• The agreement sets an agreed upon price for the business or practice. The
surviving spouse or family cannot dispute that price.
• It buys the surviving spouse and family out of the business or practice. With no agreement in place, the surviving partner is now in business with the deceased’s spouse or family. There are a lot of horror stories about this and we stress to our clients the need for their attorney to draft an agreement.
• An agreement is fine but it must be funded with a low-cost term policy. Otherwise, there are still problems.
I received a call from a medical doctor who used to be in my Toastmasters Club. He brought in a younger doctor so he could work a little less and play more pickleball. His attorney put a value on the family practice of $1,000,000. The doctor was smart enough to call and say he wanted to put a policy on them both. He was 23 years older and I suggested funding the agreement with a low-cost ten-year term. The policy wasn’t even three years old when he fell on the pickleball court and hit his head. He went to a buddy who stitched him up. He didn’t heed the suggestion to get an MRI. Two days later, he died of an aneurism.
His widow received $1,000,000 and his younger partner now owned the family practice 100%. No one knows what lies before us. But proper planning can help with the sting of death.
Cross Purchase
Establishing a Cross Purchase plan is similar to a Buy/Sell agreement but differs when there are more than two partners. In a corporation, regardless of size, there may be several owners. Their percentage of ownership may be different and stock certificates are assigned to reflect that. Thus, if the company does well, the value of their stock certificates increases. It behoofs a company to have their attorney and CPA put a value on the company and update that periodically. Just as important a plan needs to be implemented in the event of death, disability, or retirement.
If one of the owners should die, based on what the agreement calls for, the company can buy out the spouse/family. Their percentage of the company is paid out by redeeming their stock. That can be achieved through either cash or through life insurance. Typically, smart companies elects to fund the plan with insurance. Most plans I’ve seen call for the spouse/family to be paid in full. If not, things can get tricky. For example, Joe dies. He is the SVP of Marketing. The company needs to immediately replace him and it takes money. If there is a plan and it isn’t funded, Joe’s salary could continue to go to his spouse/family, leaving no money to hire someone to replace him.
Strategies for Individuals and Families
There are several approaches we use to provide the amount of coverage our clients need to protect their families. We work with their attorney and, in some cases, their CPA to discuss and determine the face amount, type of insurance best suited for their needs, ability to pay and for how long the coverage is needed. If an insurance policy is needed for estate planning, the coverage must stay in-force until death. These permanent coverage policies are expensive and develop cash value which can be used to supplement retirement or be available for contingencies.
One strategy we employ for those who need coverage until death, which in some cases, can be 40-50 years from now, is to have the individual fund the first and second year’s premium. Usually, the premium we suggest is $30,000 each year. This overfunding builds enough cash value that one of our lenders will gladly loan the third and subsequent years premium on their behalf. Banks make their money by lending people money to purchase a car, boat, airplane, or home if they have a good credit score and down payment.
Unlike a car that depreciates once it is driven off the lot, or a home that could decrease in value, the cash value in a life insurance policy can never decrease. Secondly, the lender is secured by the cash in the policy. Lenders are happy to make a loan if there is no risk. Very few things in life can say there is no risk.
This policy not only provides a death benefit 30, 40 or 50 years down the road, it can provide a lifetime tax-free income stream. These policies also have living benefit riders that provide for chronic illness, critical illness, and terminal illness. They provide a substantial percentage of the death benefit for these living benefits which are paid on a tax-free basis to the person in need.
One of our clients is a family doctor who was a sole practitioner. Lucky for he and his family, he saw the merits in this plan even though his financial advisor did not. Five months after he paid the first year’s premium on a $2,000,000 policy, he called to say he was diagnosed with inoperable pancreatic cancer. The critical illness rider is paying him $12,770 a month. The total amount paid out will be deducted from his gross death benefit. In his case, if he lives long enough to receive $500,000, his spouse will receive the other $1,500,000 upon his passing.
For a younger couple with children, the use of term insurance makes the most sense. They can each be covered with a large face amount for 20-30 years for very little money. The upside is that they can protect their spouse and children when expenses are high and while the children are still at home and in school. The downside is that they have no coverage after the term is over. All the money they’ve paid into the policy is lost.
Putting a term policy on a stay-at-home wife/mother makes total sense. If the wife dies first while the children are still young, the father will need to hire someone to watch the children, prepare meals, and do the housework and laundry. Most couples don’t realize the amount of money it takes to replace mom. It’s important to consider the role both parents play when it comes to providing financial security for the family. A lot of advisors never think of this. They only put life insurance on the man which is a fatal flaw. Both sets of parents have to have peace of mind in knowing that if one of them dies, the other will have the means to raise the family just as if both parents were alive.