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Term Life Insurance and the Sole Proprietor

March 2, 2013

Last week, while discussing the differences between Term and Whole Life Insurance, we mentioned that a Term Life policy can benefit sole proprietors and small businesses when used as a succession tool. Today, we would like to go into a little more depth on this topic and explain the value of Term Life Insurance in the small business arena.

When we broach the topic of Term Life Insurance, many business owners are quick to point out that they already have some form of life insurance. These policies are often family oriented policies that name a spouse or another family member as a beneficiary. Having some type of personal life insurance policy is necessary for most of us, but it is also common for small businesses to take out Term Life policies on their owners, even when such policies appear to overlap with an owner’s personal life insurance. Why? It helps to manage the risks and contingency costs involved in business planning and succession in the event of an untimely death.

When a small business purchases a Term Life policy, it is the business that owns the policy.  The policy insures the business owner/owners. However it is the business that is named as the beneficiary.  Note that this purchase often meets the criteria of a qualified business expense in that the policy benefits the business by enacting safeguards against costs that could result from the owner’s passing.

As an example, let’s say that Mollie is a successful veterinarian and she is the sole owner of a veterinary practice. While Mollie’s husband Tom is a smart guy, he knows nothing about veterinary medicine, or maybe he has his own career in an unrelated field. Mollie passes away and Tom finds himself the inheritor of the practice even though he knows little about its day-to-day operations. Tom could do a number of things. For instance, he could sell the business or he could seek out a new veterinarian or manager to run the business in his place. However, notice that there are costs involved in seeking out a reputable buyer for the business or in hiring a qualified manager: search costs and the costs of negotiation, training, etc. Meanwhile, Mollie’s passing may have forced the practice to temporarily close. As is often the case when a sole proprietor passes away, a business may not be producing revenue to help cover these “transitional” costs or the “overhead” costs involved in things like rent, utilities and insurance. This is where a business-purchased Term Life policy comes in.

The Term Life policy can help provide the financial means for the business to continue to operate with minimal interruption and can help with the costs of transition or to pay for upkeep while temporarily suspending operations. Such a policy helps provide peace of mind to a business’s inheritors at a time when they likely have many other concerns.  It empowers those faced with difficult decisions to make choices for the best interests of their business instead of resorting to a quick and convenient solution to the succession problem.

Remember, The Avanti Reader, its parent company, associates, agents and representatives cannot give legal or tax advice. Making effective financial decisions requires a solid understanding of tax rules and regulations that are complex and subject to change. Always seek professional assistance from your qualified tax advisor, financial advisor, and/or attorney.

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