Written by: Corey Janoff
This post was originally published on our previous blog website on May 9, 2018 and has since not been revised and/or updated.
I think most people understand that if they have a spouse or children who are financially dependent on them, it is smart to have life insurance. It boggles my mind how many people I talk to who have young children and no life insurance. Zero. Zilch. Nada. Maybe $50,000 provided for free through their employer. $50,000 isn’t even enough to cover their mortgage and sometimes not even enough to cover an outstanding auto loan they carry.
If you’re one of those people (you know who you are), stop reading right now and get a life insurance policy. And purchase way more than you initially think you need. For some guidance on how much life insurance to get, read this blog post. For the rest of you who aren’t such boneheads, please continue reading.
Protecting family from financial hardship is the most common reason people purchase life insurance. Often it is the only reason people even consider needing a life insurance policy. However, there are a handful of reasons for getting life insurance:
Family Protection, Collateral for a Business Loan, Buy/Sell Business Agreement, Business Key Man Coverage, Estate Planning, and Future Planning. Not all of these will apply to everyone, but let’s take a look at them.
Family Protection
We already touched on this briefly, but I am going to hit on it again, because it is the most common reason for getting life insurance. If you have anybody who depends on you financially, YOU NEED LIFE INSURANCE.
Maybe you have a spouse who would struggle to make ends meet without your income. Maybe you have children who are not yet capable of financially supporting themselves. Maybe you are providing assistance to your parents that they depend on (financially or simply helping out). Maybe you are helping a sibling out who is down on their luck or has a disability.
If you pass away in any of these scenarios, those who are dependent on you will have to make some changes in their lives, sometimes drastic, in order to continue living.
Don’t put it off and say you will get it later. You could die in a car accident today going to work or coming home. You could drop dead of a heart attack while on a bike ride. You might be diagnosed with cancer next month and therefore be unable to qualify for life insurance.
The ability to get life insurance is based on your health and the cost is based on your age and health. It is easier to get when you are young and healthy and it is less expensive the younger and healthier you are. Rarely to people become younger and healthier over time, so don’t wait any longer.
Collateral for a Business Loan
This is probably the second most common reason we see people need life insurance. A client will tell us they are starting a business. They went to a bank to apply for a $500,000 business loan and the bank said they need to have at least $500,000 of life insurance in order to be granted the loan. They need to get a life insurance policy ASAP. Long story short, if you borrow $500k from a bank to start a business and then you die, the bank wants their money back.
This is pretty straightforward. If you want to take out a $500k business loan with a 10-year repayment period, you would first want to purchase a $500k life insurance policy that lasts at least 10 years. A 10-year term policy would work perfectly and likely be very inexpensive if you are healthy. You would have a typical beneficiary, such as your spouse, on the policy, but you would assign the policy to the bank as collateral for the loan. This way, if you die, the remaining balance on the bank loan is repaid first and then your beneficiary (your spouse in this case) would receive the remaining death benefit.
Got it? Excellent. If you are considering starting a business one day and think you will need to take out a sizeable business loan, I strongly encourage you to purchase life insurance before going to the bank for the loan. It can sometimes take several weeks to several months (depending on health history) to get through the underwriting requirements of the insurance company before you officially have the policy.
Business Buy/Sell Agreement
Let’s say you are in business with a partner. Just the two of you. You each own the business 50/50. There could be more than two founders/owners of the business, but we will keep it simple with two for now. Let’s say you have built a pretty successful business and the business is valued at $10 million.
Odds are you and your partner have an operating agreement (a contract) that stipulates the terms of your ownership. If you have done proper business planning, part of that operating agreement will include a buy/sell agreement, which stipulates what happens if the two of you decide to part ways.
If your ownership stake in the business is valued at $5 million each, you want to make sure you get that full $5 million if you leave your partner. It doesn’t have to be a bad breakup – maybe you mutually agree to part ways because you want to pursue other interests. Or vice versa. If your partner leaves you and you want to continue running the business and own it outright, how are you going to buy out the $5 million of shares from your partner? This will all be detailed in the buy/sell agreement the two of you signed.
What happens if one of you dies? If you pass away, you likely want your $5 million of business equity to be passed onto your family. Maybe you want your spouse or children to step into your role in the business and fill the void, but odds are that’s probably not going to happen. They would rather have the cash and your partner doesn’t want to be forced into a business partnership with your spouse and children. And you don’t want to be in business with your partner’s spouse and children if he dies.
So you both take out $5 million life insurance policies on each other. That way, if your partner passes away, the insurance will pay and you can buy out your partner’s shares in the business. Now, you own the business outright, your partner’s spouse and children have the $5 million. Everyone is happy.
Business Key Man Coverage
Key man insurance is similar to buy/sell insurance in the sense that the goal is to create liquidity if a key employee passes away. Maybe Mary is your company’s accountant, CFO, and is there to fill in when you are on vacation. If something happens to you, she is next in line to run the company. Heck, she basically runs the company now. She is the only one who handles the books for the company. Not so much as a dollar goes in and out of the company without Mary knowing about it. She handles all of the meetings with your investors and business partners. If something happens to Mary, your company is in big trouble.
What if Mary dies? You will be scrambling to fill her void. Investors might bail on your company. Revenue might slip while the company diverts energy from its core business functions and focuses its energy on filling Mary’s shoes. Well, if you have a life insurance policy on Mary, it won’t fill her shoes, but it will provide some much needed cash to help you weather the storm.
Smart businesses of all sizes will purchase life insurance policies on their key employees. You might have a star salesman, a key manager, or someone else who would be extremely difficult to replace. The payout from the life insurance can help offset lost revenues, cover recruiting costs of finding a replacement, among other things.
Estate Planning
At the federal level, estate taxes won’t be an issue for most people, now that the exemption is $11 million per individual ($22 million for married couples). This means that when you die, no taxes will be owed to the federal government unless your net worth is greater than $11/$22 million. Kind of crazy yet unsurprising that once you are worth over a certain amount, the government taxes when you die. On top of that, some states have either an estate or inheritance tax (or both). This is usually assessed at a much lower threshold. For example, in my home state of Oregon, you owe state taxes if you are worth over $1 million when you die. www.TaxFoundation.org updates an annual list of the states with an estate/inheritance tax.
If you are fortunate enough to be over the federal exemption, or unfortunate enough to live in a state that levies a tax when you die, you may elect to purchase a life insurance policy to cover the tax bill. That way, your assets can be passed onto your heirs without your heirs having to cut a check to Uncle Sam.
You have to be strategic with how this is done, because if you own your own life insurance policy, it is included in the value of your estate, which would increase the taxable amount. You can avoid this by holding the life insurance in a trust. Work with an estate planning attorney to properly set up the estate plan so everything is done correctly and works in your favor.
Taxes aside, you may own illiquid assets that you want your family to retain after you pass away. A common example is real estate holdings. Maybe you have numerous residential rental properties, maybe even some commercial properties. If any of those properties have outstanding loans attached to them, when you die, the bank is going to be calling asking for those loans to be repaid ASAP. Otherwise they will foreclose on the property. Your heirs may not be financially capable or creditworthy enough to secure proper financing to take over those notes. They may be forced to try to sell the properties at fire-sale prices. But if you have a life insurance policy to cover the outstanding loan balances, when you die, the loans will be repaid to the banks and your heirs can inherit those properties free and clear.
Future Planning
After reading the above reasons for getting life insurance, hopefully I was able to get your brain churning and daydreaming about your future. Maybe you are young and single now, but have aspirations of starting a family one day, or owning a business, or having a portfolio of real estate properties. If so, you should plan ahead and secure life insurance now.
Again, the ability to qualify for life insurance is based on your health and the cost is based on your age and health. It is easier to qualify for and less expensive today than it will be tomorrow. Or next year. Or in ten years.
I bought my first life insurance policy when I was 24 years old for this very reason. I didn’t own a home. I was single. Didn’t even have a qualified prospect for a future spouse. No children (that I knew of – kidding…I hope). Didn’t own a business. But I knew one day I would want all of those things and I also knew that good health isn’t guaranteed to last. I was young and super healthy. Still played sports, exercised 6 days a week. I qualified for the best health rates possible.
One of my friends had a heart attack at the gym on Christmas Eve at age 30. He had another one a few years later. He was very fit and always health conscious. He’s the last person I would have ever suspected to have a heart attack. I have a cousin who was diagnosed with lymphoma at age 24. Another cousin who had a melanoma in her 20’s. As a result, my cousins are going to have to wait a decade before they can qualify for any life insurance and my friend would get slapped with very expensive rates if he can even get approved (I don’t know his full medical history).
You just never know when something could happen to you that will affect your health and therefore affect your ability to qualify for life insurance when you actually do need it.
So be proactive and get a policy when you are young and healthy. Use your age and health to your advantage.
