Life insurance, originally designed to offset the adverse financial effects of the early demise of a family’s breadwinner, has evolved into an extremely versatile tool, capable of solving a myriad of financial problems. One of the problems that it solves very well is that of a business owner trying to leave his estate equally to all his heirs. Let’s take a look at the problem, and how life insurance can help to solve it.
Often times, the business represents the largest portion of the business owner’s estate. That in itself is not a problem. The problem arises when the business owner has two or more children, with at least one, but not all of them active in the business. How then does the business owner divide his estate equally amongst his children, treating them all equal from a financial perspective?
One way would be to just divide the estate equally, so that if there are three children, they each receive one-third of the estate, including the business, even if only one (or two) of them is active in running the business. I submit to you that that method is a recipe for disaster. There are just so many things that could go wrong with this approach that it is a virtual certainty that at least one of them will actually happen.
The sibling(s) not involved in the business will look at it differently than the one(s) running it. If the outsider(s) is (are) not as financially successful as the insider(s), he/she (they) might look to the business to provide some type of financial assistance. This obviously may not be in the business’ best interest, and could have an adverse effect not only on cash flow, but also on the siblings’ relationships with one another. Worse, if the outsiders own a combined majority interest, they would have control.
If leaving the estate equally to the children doesn’t work, what is the answer? First and foremost, the business must be left only to those heirs actually involved in running it. This can’t be stressed enough. In addition to this being fair to the parties involved, it also provides the best opportunity for the continued success of the business.
Here is a hypothetical example of how life insurance can be used to equalize an estate, while leaving the business to only those actively involved with it. Let’s say the total estate is $5,000,000, comprised of a $3,000,000 business (a professional valuation should be obtained for this purpose as well as for IRS purposes) and the $2,000,000 balance in real estate, securities and qualified assets. Let’s further assume that there are two heirs, one involved in running the business and one that has no interest in getting involved in the business.
If the business owner follows my advice and leaves the entire business to the heir involved in running it, the other heir would receive an inheritance worth $1,000,000 less. Naming the non-business heir the beneficiary of a $1,000,000 life insurance policy (provided the business owner is insurable), could easily rectify this inequity. This method provides tremendous flexibility, not only in business transfers, but also in regard to specific bequests, such as artwork, vacation homes and family heirlooms.
This is but one of the many non-traditional uses of life insurance. That is why it always amazes me when someone state unequivocally “I won’t need life insurance when I’m older.” A more accurate statement might be “If things continue to go as planned, I probably won’t need the life insurance that you are proposing for the use for which you are proposing it today.” Meaning that while financial success can eliminate some needs, it can also create new needs.