Quick, can you think of a domestic industry that, in 2011, was comprised of approximately 735,000 establishments, was responsible for approximately $745 billion of economic output and employed nearly 8 million people? Time’s up! The answer is the domestic franchise industry.1
The U.S. franchise industry is extremely large, growing and quite diverse. It is comprised of many different types of businesses, ranging from restaurants, retail stores and hotels to a wide variety of service and consulting businesses.
If you are working with existing franchise clients or prospecting for new business clients, you may wish to invest some of your time learning more about franchising and some of the more important retirement, succession and estate planning challenges facing successful franchisees today.
Understanding the needs of a franchisee starts with being knowledgeable about the foundation of the franchise. The two most important documents usually reviewed by a prospective franchisee and his or her tax and legal advisors are the franchisee disclosure document (FDD) and the franchise agreement (FA).
The FDD (formerly referred to as the uniform franchise offering circular, or UFOC) is a disclosure document that franchisors are required to provide to prospective franchisees by law. The FDD contains important information about the franchisor, the franchise and its management team. An FDD will also include other important disclosures concerning the franchise opportunity, royalties and required investments, earnings claims, litigation and other material operational and financial disclosures. The FA needs to be considered by franchisees and their advisors in connection with retirement, succession and estate planning matters because some FAs might limit the transfer of franchise business interests to conditions during life or at death.
Personal life insurance planning
When it comes to personal life insurance planning, it usually makes sense to begin with a comprehensive life insurance review. This review should consider accumulation and protection goals, premium tolerance, tolerance for investment risk, the need for spousal and juvenile coverage (if any), family income and wealth transfer objectives, debts, mortgages and other important personal, family or charitable goals.
See also: Selling Your Prospects on Life Insurance
In more complex situations, you may wish to consider developing a life insurance portfolio for top franchise clients. For example, assuming there is a death benefit need, consider using high premium, high cash value and lower death benefit designs to maximize cash value accumulation using whole life, universal life or variable universal life products. This high cash value coverage might be owned personally or by a spousal lifetime access trust (SLAT) if estate taxes are a concern.2 If lifetime cash value withdrawals and/or loans are expected, keep premiums within the seven-pay limit to avoid modified endowment contract (MEC) status. This is because distributions and loans taken from MECs are not taxed as favorably as those taken from non-MECs. For more information on MEC rules, please see IRC 7702A.
When funding family income needs, consider a low premium and high death benefit product such as term insurance, universal life or a whole life contract with a term insurance rider. This low-cost coverage may also be owned by an irrevocable life insurance trust (ILIT) if the goal is to protect the insurance proceeds from estate taxation in the insured’s estate.
A third or fourth piece of the life insurance portfolio might also include additional coverage (either single life or survivorship coverage) for wealth transfer purposes. For example, an ILIT might be used to own coverage for estate tax purposes or to provide financial security for grandchildren if the trust is designed as a dynasty trust.
Business life insurance needs
Franchisees have three very important business life insurance needs: life insurance and nonqualified benefit programs for key employees and life insurance-backed business succession arrangements.
Key person life insurance is typically used to create capital to offset the loss of one or more key employees, to recruit new executives, to retire debts, or for any other necessary business purpose.3
A second important use of business life insurance is to retain top talent using nonqualified benefit programs, such as bonus plans, split dollar and nonqualified deferred compensation arrangements. Nonqualified plans are very cost-effective benefit plans since these programs are very selective in terms of who is covered and the type and level of benefits that are provided.4
Please remember, if the business is the owner of the life insurance, certain notice and consent and other requirements must be followed to protect the tax-free nature of the death benefit. For more information on these requirements, please see IRC 101(j).
The third important use of life insurance for many franchisees typically involves succession planning (e.g., buy-sell planning) or using life insurance when succession planning options for the business might be limited or unavailable.