What happens to your company when you die? Making sure you have a continuity plan in place can ensure you have a smooth transition and ease the burden on your family. Life insurance can be a big part of that plan. Here’s what you need to know when looking for a policy.
Topics we cover in this episode include:
- Why you should start thinking about life insurance when you’re young
- Tax considerations for key person life insurance
- How a buy-sell agreement can help pass the company on
- How to keep your company operating as it was after something unexpected happens
- The different types of life insurance
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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com
[00:00:05] Wade Carpenter: What happens to your company when you die? Making sure you have a continuity plan in place can ensure you have a smooth transition and ease the burden on your family. Life insurance can be a big part of that plan. Come on in, let’s talk about it.
This is the Contractor Success Forum. If you’re new here, I’m Wade Carpenter with Carpenter Company CPAs. With me is my cohost, Stephen Brown, with McDaniel Whitley Bonding and Insurance.
Stephen, you and I have told some war stories over the years about what happens when a contractor dies. Kick us off with some thoughts on this.
[00:00:36] Stephen Brown: Well, it’s a sad way to start a podcast, but yeah, it does happen.
And you and I both have customers that we deeply loved and respected that passed away. And in certain situations, what you leave as a contractor for the succession of your company continuing to operate can be easily planned for ahead of time and funded at very little or no expense.
What I wanted to talk about is the funding of a succession plan today. And also ways life insurance helps your estate, helps your spouse. If you’re a sole owner of a corporation and you don’t have key employees finishing a project, life insurance is the key.
Why you should start thinking about life insurance when you’re young
[00:01:19] Stephen Brown: And the reason you start thinking about life insurance now is while you’re young, and the younger you are, the lower the mortality charges are. Mortality charges are based on a rate, based on everyone’s age and health.
And you might say, I don’t appreciate you charging me more for my life insurance because you think I’m going to die. They don’t care. They take all the information, statistics. And they develop mortality tables, and these are done by actuaries. And these actuaries are absolutely math geeks.
[00:01:53] Wade Carpenter: Worse than bean counters. Oh yeah.
[00:01:58] Stephen Brown: They’re obsessive with analyzing the details and the risk.
And you can tell so much of it in a life insurance application. But, if you’re young and you want to buy life insurance, then the proceeds of that life insurance can go to keep your business running, can keep paying all your expenses, can educate your children, and keep your spouse going.
As an insurance agency, we not only sell life insurance policies, different policies, but we also work with key advisors, lawyers who develop trust and estate tax planning strategies that are funded by life insurance. So, that’s why this subject matter is coming up today.
[00:02:42] Wade Carpenter: Okay. Well, nobody really likes to even think about life insurance. They don’t like to even think about paying life insurance, but it is a necessary evil sometimes and actually is a great planning vehicle in this case.
Can you tell us about a few different ways of life insurance might be used? You mentioned key person and–
[00:03:02] Stephen Brown: Right,
[00:03:03] Wade Carpenter: Can you just walk through a few of those examples for us?
Tax considerations for key person life insurance
[00:03:05] Stephen Brown: I have a customer with a number of key people and they bought life insurance on these key people, payable to them for the proceeds. You can do that. If something happened and they died prematurely, they’d have to be replaced at a considerable expense.
So, part of the key person If you stay with me until your age X amount, then I will give you the life insurance policy, along with the cash value that’s built up.
That particular customer expensed the insurance premium as a company expense for the key man life insurance policy. But the proceeds would have been taxed when he transferred it to the key employee. So there’s a lot of issues in how you pay that premium and how the IRS looks at taxing it.
So that’s the main thing about key person life is you’re protecting yourself if that key person dies mid project, mid term. You have the expense of hiring someone else and you have the loss of productivity of that employee who was literally a key person to your organization.
[00:04:11] Wade Carpenter: Usually I think of key person more as the owner. And, a lot of times in a construction company, or any company, usually a lot of stuff does revolve around the owner, but–
[00:04:20] Stephen Brown: Yeah, if you’re the owner, you’re a key person. You need life insurance as well.
[00:04:24] Wade Carpenter: Right. But I’ve–
[00:04:25] Stephen Brown: You would set up your life insurance to go to your beneficiaries to finish up the projects and keep your family financially secure.
How a buy-sell agreement can help pass the company on
[00:04:34] Wade Carpenter: Well, yeah, and I’ve also seen where, maybe you’ve got a project manager, call it vice president or whatever. They play a significant role in there. And what if you don’t want your construction company to really die, or maybe pass it on to them, but they don’t have any money to really buy into your company or pay for what it’s worth.
How can you protect yourself with stuff like that?
[00:04:56] Stephen Brown: Well, on buy, sell agreements, life insurance can fund the buyout of that buy-sell agreement. First of all, you can build up cash value in the product. So the cash is there. You’ve got a vehicle that is funding the buyout of this. But you’re also, in case there’s a sudden death involved of one of the partners in a buy-sell agreement, then there’s cash to buy out their share.
So, I tell customers with a partner in the business, do you want to work with your partner’s wife? Do you want to have the life insurance to fund buying that partner out that’s payable to you? And it’s been a fantastic vehicle.
We mentioned funding it with cash, and there’s term insurance that is less expensive that only pays the death benefit if you die. But it’s a lot less expensive and I’m having to do a lot of that in my older contractors that are funding buy-sell agreements and succession planning. The good news is folks are living longer, so, even at age 50, you can get a 30-year level term policy for fairly large amounts of death benefit.
[00:06:04] Wade Carpenter: Yeah, I’ve seen that too. And I will say it’s usually a lot easier to figure out something like a buy-sell agreement before something happens than trying to figure it out in probate and dealing with, say, maybe a spouse that has nothing to do with the business and a lot of the value can go out pretty quickly. But that’s where I wanted to transition.
How to keep your company operating as it was after something unexpected happens
[00:06:25] Wade Carpenter: When something happens unexpectedly and somebody dies, a lot of times the value of the company and the confidence of the company can go away with that, with the owner or whatever.
But sometimes there’s overhead and expenses and those kind of things that are going to continue. And you’ve got a, basically a shock in your company’s system where things are not going to operate immediately like they should, or they have been. So, is there a way to work around that?
[00:06:53] Stephen Brown: In your succession planning, in your key person agreement, in your buy sell agreement, you literally get together and you put together the common conditions that you want to meet. And then you decide how you’re going to fund the results of those conditions.
For example, you’ve got two partners and one of the partners couldn’t care less about the buy-sell agreement. And then you as a partner are very interested in it because you know your partner and you just think, well, my spouse is just going to get screwed upon my death. Trying to get the value out of the company that’s really there.
We talked about the different construction company setups where there’s deferred income that has to be paid, and no cash to pay it. So then it’s real easy to say upon the death of your partner, hey, the company’s not worth anything. What do you want from me? So, life insurance is a huge way to pay pennies on the dollar to fund an accidental death situation. Buy-sell agreement, key person, or succession planning.
[00:07:57] Wade Carpenter: I was also thinking the overhead and covering those kind of things.
[00:08:00] Stephen Brown: Absolutely, that doesn’t go away. Say that you’re the sole owner of a corporation, and you don’t have a partner, you have all that overhead, you have all those notes, you have those taxes for the business entity that just don’t go away.
[00:08:14] Wade Carpenter: Right.
[00:08:15] Stephen Brown: And you might say, well, I don’t care, I’m dead. But then that’s why people don’t buy life insurance because they don’t care.
Strangely enough, Wade, life insurance is a product that just does not sell itself generally. If you need insurance on a vehicle, you’re like, yeah, I’m going to get pulled over and get arrested for not having insurance, or I’m going to get in a big wreck and they’re going to take away everything I own because I don’t have insurance.
[00:08:38] Wade Carpenter: Right.
[00:08:39] Stephen Brown: But life insurance is something like, really? My advice is just get a quote, get it knocked out. Find a key advisor. Usually your life insurance agent is someone that does nothing but offer solutions for different situations that you want to meet.
So you go to your insurance agent and you say, this is what I want to accomplish. What do you suggest? And they’ll come up with some different products and ideas, and then you can look at it and look at the premium that they estimate you’ll have to pay, and it’s just estimated on your age in general. Health conditions and it can change by the time it’s rated up, by the way.
But what’s the harm of doing that? You say, well, once I open the door, these life insurance agents are so pushy, they’ll never let me alone. Just go to your property and casualty agent that handles the insurance for your company. I do it all the time. I’m not obnoxious about it. But I will remind them, this was important to you. Has that changed? And I might say, yeah, it’s changed. It’s not anymore. Okay, I just, I leave it.
But if you need it, let’s get going, because it’s not just ordering insurance on a piece of equipment. Oh yeah, I got you covered, it’s done. There’s some work involved, there’s some questions, there’s some applications, there’s some things you may not like.
As a general rule, most all the insurance companies now will send a nurse to meet you at your home or place of employment to get the health stuff knocked out. To do the fundamental work. When you’re young and you need a lower amount of coverage, there’s almost no physical visit from a nurse. So that’s not anything to be afraid of.
And I want to say too, Wade, I had a customer who desperately needed life insurance for a half a dozen reasons, and he was rated up because he didn’t tell me, but it just turned up that his father died early of a heart attack, and he was one of four brothers, and his other three brothers had died prematurely of a heart attack. It was a huge hereditary risk in their family.
And when they rated him on insurance, they charged a little bit more for the premium. He just pitched a fit, absolutely pitched a fit. And did not buy the insurance. And furthermore went and spent a lot of the money that they had saved up on just crazy stuff and then died. And the widow struggled literally for 15 years to get her head up above water where she could get rid of the company and survive.
[00:11:14] Wade Carpenter: Well, it’s sad, and I know there are things like providing group life insurance for your employees can be a nice little benefit.
The different types of life insurance
[00:11:20] Wade Carpenter: But can you talk a little bit about the different types, like term versus whole versus, I’ve seen some of these things where universal life and variable universal life and–
[00:11:31] Stephen Brown: Well, and–
[00:11:32] Wade Carpenter: AULs and.
[00:11:33] Stephen Brown: Also, each of the life insurance companies have different sexy names for their products, so it’s really important to see what it is you’re being pitched and why. So a term policy builds up no cash value. It’s just based on the Mortality charges and expenses of the Life insurance company for X number of years.
So you can buy term policies usually in five year increments. Five years, ten years, fifteen years, up to thirty years, depending on your age. And a term policy is level, it doesn’t go up. During the whole term of the policy, it remains the same. So, that’s a term policy.
Whole life builds up cash value. And a whole life policy is designed for you to have cash value built up in your company that as mortality charges go up and you get closer to your real old age that there’s enough cash value to pay the premium on that. Because when you get older, the face amount of the policy and sometimes the cash value get to be about the same. So that’s a whole life policy.
Variable life usually takes that cash value and invests it in some kind of mutual fund, stock market, something like that. So the life insurance agents selling variable life products have to have a security broker’s license to sell those products.
Then there’s Universal Life, which is a combination of the two. And then there’s Indexed Universal Life, where your life insurance is tied to Dow Jones or NASDAQ stock market.
Why you should consider a Group Life policy as a benefit to your employees
[00:13:07] Stephen Brown: Then we talked about Group Life is another type, that’s something that usually you can, it’s three times the amount of your salary as a general rule. And every employee of the organization has that coverage.
So, I can tell you it’s not that expensive and also you can get some folks covered that might be harder to insure. But there are group life insurance rate is a fantastic benefit that almost every employee of yours really appreciates. It does not build up cash value, but it covers that employee during the term that they are working for you.
[00:13:40] Wade Carpenter: Yeah.
[00:13:41] Stephen Brown: Another incentive, too, to continue to work for you. I’ve got group life. So, it’s very inexpensive and it’s a wonderful way to protect your employees. And if you don’t have that, an employee dies and you’re funding a whole lot of expenses for that family too.
[00:13:56] Wade Carpenter: That’s what I was thinking. Yeah, I’ve seen that.
[00:13:59] Stephen Brown: Then there’s final expense coverage, you see that on TV all the time. It’s just enough to pay to get you buried. So, it’s a very little benefit, very little health insurance questions. Most contractors aren’t interested in that.
So, those are the different types of policies and we’ll post on our show notes a lot more about explaining the different policies, the different options, why you would get life insurance, and how the proceeds are taxed.
This is something I know you’re familiar with, but life insurance, personally, my life insurance that would go to my heirs, it’s not taxed. Anything you get from life insurance proceeds are not taxed. Unless it’s a transfer of ownership where they’re on a key man policy, or you’re deducting it as a business expense, and you personally are the beneficiary, there’s some tax consequences.
And so you have to think about how you structure that, as far as what you want to get out of it.
[00:15:01] Wade Carpenter: We can go into that, and I don’t know if you want to really dive deep into these products, too, or whether you’re selling some of these universal life–
[00:15:10] Stephen Brown: No, I just wanted our listeners to understand the different products. And a lot of times what you see a life insurance agent do is they’ll show you projections. Look, based on current statistical information, this is what your policy could do for you. And based on historical stock markets over, this is what your policy can do for you.
Well, if they’re a legitimate A-rated life insurance company, those projections will show you a guaranteed basis versus what it could do, how it could perform. So, make sure you’re talking to a reputable life agent.
[00:15:45] Wade Carpenter: I’ve seen a few in the last few years trying to sell these IULs, Indexed Universal Life Policies. And I understand there’s some benefits to them, but I think some of the ways that they’re explained to clients, or at least some of the ones I’ve seen, honestly have been a little sleazy because it’s been very misleading. And I probably shouldn’t say that out loud, but.
[00:16:09] Stephen Brown: I understand what you’re saying. You remember me telling you that life insurance does not sell itself, so you have to be mildly pushy to get life insurance policies sold, unless you just called up and said, Stephen, here’s my situation, here’s what I need, what do you recommend?
Okay, good. What’s the price of that?
[00:16:26] Wade Carpenter: Right.
[00:16:26] Stephen Brown: That’s what I do.
But I used to work for a large life insurance company as a college agent, believe it or not. You wouldn’t believe how we were taught and drilled on our sales presentation and these projections. And it was really ridiculous that I did that.
I majored in insurance in college and I thought, well, this is a job, but I was paid only on straight commission and encouraged to sell life insurance policies to my friends and fraternity brothers and so forth. And all we were worried about is getting enough money for a six pack of beer. We couldn’t care less about life insurance.
So anyway life insurance is a wonderful business. The people that do it well and have a good reputation work their tails off because commission is usually a one time deal. So there’s no recurring income to them, and it’s like a real estate agent. That’s why they make more commission, because you can only sell that house for you just once.
So. You’re constantly working, you’re constantly hustling, you’re constantly marketing. So that’s why I say you might want to just talk to your P&C agent. They’re going to make sure that if they don’t hand you your life insurance, they refer you to someone that’s not going to be a pain.
[00:17:36] Wade Carpenter: Right. Okay, well, I didn’t know if you wanted to go into any other details on things like state taxes or policy loans.
[00:17:45] Stephen Brown: Well, our last podcast was on taxes. This one’s on death and taxes. Yeah, you can’t get out–
[00:17:51] Wade Carpenter: People love to talk to us..
[00:17:54] Stephen Brown: Death and taxes and death taxes, estate taxes. Depending on whatever administration’s in power at the time depends on how much estate taxes. The whole concept of let’s just tax your estate. Even though that estate has grown and you’ve paid taxes on everything that made that estate grow, let’s tax it again.
Well, do you want your heirs to have to sell everything they own to pay estate taxes? No. You want a life insurance policy that pays those estate taxes for you.
And if the estate taxes are down, that’s just more money for your heirs, but you’ve got to do some planning for that. You might want to set up different trusts and vehicles for transferring your wealth to your heirs.
Our old minister once said, I think of trusts as they should be called mistrusts. Because it’s a way to manipulate family members. And I disagree with that. If a trust is set up right, it’s designed to minimize your taxes and not to manipulate your heirs. Now, you may want to do both. You can use them for both, but.
[00:18:59] Wade Carpenter: Well, you’ve given us some great information. Any other parting thoughts or things we didn’t hit today?
[00:19:05] Stephen Brown: No, the main parting thought is just do it now. If you’re thinking about doing it at least look into it now. See what it will cost. I can tell you that if you’re a young contractor with a family to take care of, you should have some life insurance on your shelf. It’s not expensive. If you’re young, it’s not expensive.
And the construction business is a dangerous business. So, things happen. The good news is the life insurance, they don’t rate you up for being a contractor. They rate you up if you’re a pilot, and you like your hobby scuba diving, you pay more. And then they decline you if you’re a tightrope walker over Niagara Falls and stuff like that.
So anyway, as a contractor, you’re just considered like any other business person, but it is a riskier trade. Enough said there.
[00:19:54] Wade Carpenter: With that, thank you all for listening to the Contractor Success Forum. Check out the show notes at Contractorsuccessforum. com or the Carpenter CPA’s YouTube channel for more information. We would appreciate it if you consider subscribing and follow us every week as we post a new episode.
We will look forward to seeing you on the next show.