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Do you have a succession plan for your business? Do you have an agreement to make sure your desires for your business are fulfilled in the event of your death or disability? Will you force family members or even the courts to decide?
As a business owner, you might not know what kind of investment options you should carry for yourself and/or your employees. Montgomery can help you with these decisions, and talk you through the process to implement the right plans for your business.
As a small business owner you are responsible not only for the welfare of yourself and your family but for many others as well, including partners, employees and customers. Whether you run your business out of your home or from an office, factory or warehouse, a well-conceived insurance and benefits program is essential.
It can help protect your family and your business if you die or become disabled. It can help you bridge an important gap if one of your key employees dies or leaves the business. It can assist you in attracting and retaining the best talent. And depending on the size of your company, it can even offer an innovative way for you to compensate your most valuable team members.
One of the first things any business owner needs to consider is how to protect against events that may threaten the future of the business, like the death or disability of a proprietor, partner or key employee. Individual Life Insurance
Let’s start with the worst-case scenario, the death of one of the business owners. What will happen to your business if you die? Many small business owners take out loans to help grow their businesses, and often secure these loans with personal assets. If you have business loans and were to pass away before they were paid off, you might think your family could sell or liquidate the business to cover the debts and provide financial security for them.
In reality, this rarely happens. When the family is forced to sell the business quickly, they may have to sell at a discount or during market conditions that make the business less attractive. In other cases, the business may be worth very little without the proprietor or partner. Individual life insurance can protect your family by providing funds to cover debts, ongoing living expenses, and future plans in the event that something happens to you.
Life insurance also can be structured to fund a “buy-sell” agreement. This is an agreement among owners to buy a deceased owner’s share of the business at a previously agreed upon price in the event of death, disability or retirement.
Why are these agreements so important? You might think that if you die, your family could maintain their income by running the business themselves or by hiring someone to handle the day-to-day management. The fact is, your loved ones may not have the skills or the desire for the job, and your co-owners may not welcome the idea of an unintended partner. With a properly structured and funded buy-sell agreement, your business partners won’t have to scramble to come up with the money to buy out your share of the business and you’ll be guaranteed that your survivors will be compensated fairly and promptly.
Buy-sell agreements are typically funded by life insurance policies purchased on the lives of each of the business owners. The amount is usually specified in a contract created with the help of an attorney. You can enter into a buy-sell agreement at any time, but it often makes sense to do so when a business is formed or when new owners are brought into the business. Because business values can fluctuate, it’s important to review the contract with your accountant at least once per year or to include a calculation method in the agreement. Also be sure the insurance coverage funding the agreement is up to date.
Though not as common as insuring against death, business owners can also insure against the risk of becoming disabled and unable to work. In this case, disability income buyout insurance would fund the buy-sell agreement, allowing the disabled owners to be bought out, typically after a one-year waiting period.
Key Person Insurance
Key person insurance is another essential component of a smart business continuation plan. Key person insurance is life or disability insurance purchased by the business on the life of such an employee and payable to the business. When a “key person” dies or becomes disabled, insurance can help make up for lost sales or earnings or cover the cost of finding or training a replacement.
Employee Benefits Retirement Plans
With the exception of health insurance, retirement plans are the benefit employees desire most. The good news is that small business owners have a variety of plan options from which to choose.
Most retirement plans fall into one of two major categories:
- Defined Benefit plans – Commonly known as pension plans, defined benefit plans require employers to pay a fixed annual amount to eligible employees during their retirement years. They allow employers a high degree of tax savings, and in good times, favorable growth rates can reduce or eliminate the employer’s contribution. However, they can be costly to administer and may require higher contributions in times of poor or negative investment returns. Because of the high costs to employers, defined benefit plans are few and far between today. The trend has been toward defined contribution plans, where employees assume a much greater responsibility for contributing to their retirement savings.
- Defined Contribution plans – These plans allow employers and employees to contribute a set amount or percentage of pay, and retirement benefits are based on the actual performance of the funds. Defined contribution plans give the employer better cost control as the contribution is defined. The amount an employee can contribute is based on a percentage of their salary up to a maximum amount defined by law.
Defined contribution plans can take many forms, including:
- 401(k) and Profit-Sharing Plans – 401(k) plans allow employees, often matched in whole or in part by their employers, to set aside a portion of their salary for retirement. The employee is not taxed on this income until withdrawals are made, and the employer’s cost is a tax-deductible business expense. Employees can select the investment vehicles into which their funds are deposited. Retirement benefits are not guaranteed, however, and while the sum at age 65 may be substantial, it can also be much less if the employee has made poor investment choices or the stock and bond markets have not performed as well as expected. Employees can borrow from their 401(k) plans for education, a new home, a medical emergency etc., although the loan must be repaid within a certain specified period of time. Sometimes employers elect to integrate the 401(k) plan with a discretionary profit sharing plan that can increase the employer’s retirement contribution for employees.
- SIMPLE Plans – This option for companies with 100 or fewer employees allows an employee to contribute a percentage of his or her salary up to a fixed maximum to an Individual Retirement Account (IRA). The employer may also make contributions on a fixed or matching basis. SIMPLE plans are easy to set up, require minimal paperwork, and have low administrative costs. Plus, employees retain their SIMPLE account even if they change jobs.
- Simplified Employee Pensions (SEPs) – Created with the small business owner in mind, SEPs allow employers to set up IRAs for themselves and their employees. The employer contributes a percentage of each employee’s salary each year, up to a fixed maximum. SEPs have low administrative costs, and can even be started by those who are self-employed. Since the business owner can decide how much to contribute each year, this type of plan is often the answer for businesses that may want to adjust their contribution based on the health of the business.
- Payroll Deduction IRAs – This type of plan, which requires no employer contribution, is designed solely to help employees fund their Individual Retirement Accounts. Employers set up a payroll deduction system that allows employees to regularly contribute to their IRAs. Contributions are tax-deductible to the employee, just as they would be with traditional IRA contributions.
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