There are many tools in the estate planning toolkit, so there is an ideal course of action that can be implemented to address any situation. This is one of the reasons why it is important to discuss your objectives with an attorney. Many people do not understand what is possible, and uninformed decisions can yield negative consequences.
With this in mind, we will look at a couple of different ways that life insurance can play an integral role in estate planning for small business owners.
For the purposes of this explanation, let’s assume that you are the owner/operator of a large and successful bar and restaurant. The building itself is a valuable piece of real estate, and you have developed a booming clientele over the years.
You have invested a great deal of time, effort, and money in the business, so it is your most valuable possession by a wide margin. When you are engaged in your estate planning efforts, you know that you want to leave equal inheritances to each of your two children.
Your daughter worked in the restaurant part-time during high school, and she always had an interest in cooking and restaurant management. She went to culinary school, and she followed up the hands-on training with a degree in hospitality management.
Since graduation, she has poured all of her talents and energy into the family restaurant. Your son was never interested in the hospitality business. He has taken a different career path as a teacher, and he lives in another state.
Clearly, you want to leave the business to your daughter, and she deserves it. On the other hand, you love your son equally, and you do not want to shortchange him when inheritances are being distributed. What do you do under these circumstances?
The commonly embraced estate planning solution is life insurance. You can determine the value of the business that you will be leaving to your daughter, and take out a life insurance policy that will pay out that amount. Your son would be the beneficiary, so each of your children would receive relatively equal inheritances after you are gone.
Another tricky situation that can arise is the matter of succession between small business partners. If one partner dies, what happens to that share in the business? It would naturally be passed down to the heirs, but where does that leave the surviving partner?
This scenario is addressed through the utilization of a legal document called a buy-sell agreement. After they have agreed upon the value of partnership shares, each partner would take out a life insurance policy on the other that is equal to the value of a share.
When one partner dies, the surviving partner would collect the insurance company proceeds. Under the terms of the agreement, the heirs would sell the share to the surviving partner. Going forward, there would be liquidity for the inheritors and the business owner would assume total control.
This form of buy-sell agreement is called the cross purchase plan. There is another variation called the stock redemption plan. It works in the same manner, but the business as an entity would purchase life insurance policies on all of the partners or shareholders.
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