In an economic environment when most business owners are focused on short-term financial issues, insurance professionals need to help owners not to forget about the bigger long-term consequences. The economic downturn has created financial gaps for business owners. Life insurance can be an effective tool to fill these gaps, both for the short and long term.
No one business or business owner is the same, but the fast and steep economic decline of late has generated a common set of financial gaps for many enterprises and their owners. For owners of a closely held business, these gaps include:
? The Retirement Gap–The difference in a retirement income goal that can’t be filled by Social Security and a qualified retirement plan.
? The Market Gap–Because of market losses, there is a difference between the current amount of capital and the amount needed to accomplish financial goals.
? The Business Value Gap–With the business being a key element in the retirement plan, there is a need to maximize its value. Capturing the difference between the business’s book value and the fair market value is essential for the retirement plan.
? The Estate Value Gap–The decline in market values has created a difference between what owners have and what they dream of passing on.
? The Government Gap–The government has clearly promised more than it can deliver. Federal, state and local government budgets are strained, leaving a gap between what the government has promised and what will be delivered.
Although these gaps are generally short-term in nature, the tools and solutions that can fill them don’t need to be. The business owner wants to repair and restore lost wealth, but also needs to look to the future. Life insurance can help in both regards.
Life insurance is a hedge to cover the owner’s family and business in the event of unforeseen events, such as death and disability. Insurance can also be a tax-advantaged accumulation tool that helps fulfill and fund the business owner’s long term financial goals.
Insuring the gaps
The next time a business owner laments “I’ve lost more than half my wealth in less than a year,” the financial professional should help the owner put this challenge in perspective. As bad as this loss has been for the owner directly, how would the owner’s business and family feel if the owner were not around to help restore the values lost by the economic collapse? As the arduous task of restoring one’s lost fortune begins, the owner needs to insure the financial gaps against further loss. Life insurance is needed to provide liquidity in the event of the untimely death of the business owner.
The business owner is often a key source of earnings for the business and income for the family. It is assumed the owner’s continued involvement will help in the process of restoring financial losses and creating new wealth.
Because of the importance of the business owner’s earning power, it is important to hedge against the loss of that earning power. Life insurance can be compared to a “call option.” For an ongoing premium, the business and family has a “call” on a substantial amount of tax-advantaged money in the event of the owner’s death. Further, if it is permanent life insurance, this solution has a partial refund feature in the form of cash values.
For many business owners, the economic downturn created their financial gaps in two ways. First, the owner may have experienced a business downturn. Retailers have seen fewer sales; businesses with inventories are experiencing lack of financing. Second, the business owner may have financial gaps due to losses in his or her investment portfolio. Stock market losses may have deeply eroded the owner’s anticipated retirement capital.
Considering the sizeable loss of wealth that many business owners have incurred, it is unrealistic to assume that the financial gaps can be filled simply by obtaining a superior rate of return once the economy starts to recover. The owner likely must look to several different strategies to help re-accumulate wealth. Life insurance can be one of those strategies.
Since the death benefit of a fixed life insurance policy is uncorrelated to the investment market, the product offers a form of safety to families seeking to preserve hard earned wealth.
Cash values represent a tax-advantaged source of accumulation. To the extent life insurance accumulation grows tax-deferred, the high tax bracket business owner is accelerating the regeneration of wealth. Further, potentially tax-free distributions of the cash values in the life insurance policy are an additional source of wealth. Withdrawing to basis and then employing capitalized loans is a way to maximize the tax free nature of permanent life insurance.
Life insurance also represents an attractive asset class for the affluent owner working to recover lost wealth. Many permanent plans offer guarantees of principal plus a minimum interest rate. Additionally, if the insured dies before life expectancy, the tax-adjusted rate of return on the death benefit is typically very high.
Business owners are experiencing financial gaps as a result of the economy. Although it will take time to fill these gaps, life insurance can help by both insuring the gaps from unforeseen losses and providing a tax-advantaged accumulation source.
Steve Parrish, JD, CLU, ChFC, RHU, is a national advanced solutions consultant with the Principal Financial Group, Des Moines, Iowa. You can e-mail him at firstname.lastname@example.org