Life Insurance Strategies to Consider When You Own a Family Business

Not only can life insurance replace lost income, but it can help with estate taxes and provide a sense of fairness for family members who don’t participate in the business.

A small-business owner waits on a couple of customers at her bakery.
(Image credit: Getty Images)

For small-business owners, life insurance can offer many benefits, such as the typical motivator for any potential policyholder: providing the family with enough money if the primary earner dies.

Just because one owns a business doesn’t mean it’s worth a lot of money at any given moment. Even if it is, that value often isn’t very liquid and can be realized only by selling the business. Therefore, the surviving family members would be left relying exclusively on the cash flow the business produces. 

Another important reason a business owner may purchase life insurance is to provide liquidity with which to pay estate taxes when the policyholder dies. The estate tax is due in cash nine months after death. A family could be in a position of needing to use most or all available cash, borrow from a bank or quickly sell a company under duress. Life insurance is very frequently utilized to avoid these pressure situations.

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On a more personal level, when a business owner has one or more children who work within the company and additional children who don’t, life insurance can be a very effective instrument to promote fairness in inheritance. Leaving the business to those children who are involved in it, while making the other children beneficiaries of life insurance, leaves family members better off, both financially and with regard to the relationships among them.

Co-Ownership Considerations for Life Insurance

Life insurance policies can also play a pivotal role in instances of business co-ownership. There are generally two types of buy-sell agreements. One is a cross-purchase agreement, in which business owners obtain life insurance policies on each other.

This type of agreement is typically designed so that when one of the partners dies, the surviving owners can use the death benefits to buy the deceased partner’s stake in the company from their estate.

The other type of buy-sell agreement is called an entity purchase agreement, in which the company itself owns insurance policies on the lives of the co-owners. When one of the co-owners passes away, the company receives the death benefit and can use it to buy the deceased owner’s stake from their estate, but those shares then become treasury stock.

Entity purchase agreements can be very useful when there are many partners in a company, so that each partner doesn’t need to have a life insurance policy on every other partner.

In a Family, What’s Considered ‘Fair’ Varies by Family Member

Returning to the concept of family fairness: Though it is often prioritized by business owners who obtain life insurance, implementation of a plan can vary widely. To start, one first needs to define “fair” in a particular situation. Fair doesn’t always mean “equal,” and the policyholder needs to decide what they think is appropriate rather than leaving that decision up to their beneficiaries — who are likely to have differing views on the matter.

Fair is a concept that exists in the mind of the beholder, for both donors and recipients. The key is to make choices that are consistent with one’s objectives. Remember, this is all free money for the recipients. It’s a gift, not an entitlement.

Individuals aren’t obligated to leave any assets to their children, so it’s important to emphasize to beneficiaries that anything they receive is being provided out of love and generosity.

Communication Within the Family Ahead of Time Is Key

When clients seek our counsel, our role often includes telling stories. Throughout years of working in our respective fields, we have seen a multitude of situations play out in different family circumstances. We can offer helpful insight based on these experiences, as well as provide education about different options and structures. 

Though each situation has its unique elements, one universal piece of advice we’d give is the importance of communication within the family about your plan prior to death — particularly if the plan includes any aspects that your children might see as favoring one over another.

Ultimately, the decisions are yours, and you’ve earned the right to make them. However, if you want your family to get along well and spend time together after you’re gone, it’s important for them to understand what you’re planning to do and why. That conversation might also provide some perspective you hadn’t previously considered, leading you to alter the plan. 

Life insurance is a versatile tool to provide liquidity for a family that may otherwise be mostly illiquid — as well as providing for general spending needs, to cover estate taxes and potentially to help provide fair inheritances.

For business owners specifically, life insurance can offer a multitude of benefits from both a professional and personal standpoint.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC (opens in new tab) or with FINRA (opens in new tab).

Howard Sharfman
Senior Managing Director, NFP Insurance Solutions

Howard Sharfman, Senior Managing Director of NFP Insurance Solutions (opens in new tab), is a leader in the insurance business, managing one of the premier and largest wealth transfer consulting and planning firms in the country. Mr. Sharfman’s practice is highly focused on servicing families with multigenerational wealth.

With contributions from