Business Continuation for More Than Two Owners – First in a Series

One of the most difficult and perplexing issues facing business owners is how to transfer a business to successive owners. This gets especially more complicated when the transfer involves more than two business owners. Assuming that the owners (called shareholders) have a competently written Buy / Sell Agreement, the question becomes how to structure the funding mechanism.   That is, what entity owns the life insurance policies that cover each shareholder and how do you make this the most tax-efficient for everyone involved?
The easiest – and least tax-efficient – is for the Company to be the owner and beneficiary for all the life insurance policies. This way, when an insured dies, the life insurance proceeds get paid directly to the Company, which then retires the deceased’s shares and pays the heirs the fair market value of those shares, which is presumably the amount of the death benefit of the life insurance paid. By extension, the remaining owners’ shares appreciate by the value of the deceased shares. The trouble with this arrangement is that the tax basis for these shares remains the same. This means that, when the remaining owners sell their shares in the business, they pay capital gains on everything over-and-above their original tax basis – including on the appreciation from the newly acquired shares.

Can they do better? Most definitely yes! To find out how, go to:

Modified Endowment Contracts (MECs)

A Modified Endowment Contract (MEC) is simply a permanent life insurance policy gone awry. In layman’s terms, a MEC is a life insurance policy into which the policy-owner put too much money into it too fast. This results in any distribution taken from the policy (including loans) are taxed as ordinary income. If you are younger than 59 1/2 when you take the distribution, tack on a 10% penalty courtesy of the IRS. Distributions include collateral assignments, cash dividends, dividends applied for any purpose other than to reduce premiums on the same contract, full and partial surrenders and account withdrawals.

How do you MEC a life insurance policy? Answer: by paying too much into a policy over the first seven years. This amount is determined by the IRS, who sets the maximum amount of premium that can be paid into a policy for the first seven years from the date of issue. Also, you can’t avoid MEC by simply paying less in later years. Once you exceed this limit, it’s like jumping off a bridge: you can’t undo it!

The best way to avoid MECing your life insurance policy is to have your initial life insurance illustration run to avoid it.  If your agent is competent, he or she will take care of that for you – but it’s worth the question so that you’re not surprised later.  Life insurance software will automatically run your illustration to avoid MEC. Yes, it’s that simple. Want more info? Go to:

Estate Planning – Equitable Distribution

How to distribute business assets when only two of the three children work in the family business?  Here’s how we worked this one out…….

Situation:  A 62 yr-old owner of a medical supply company valued at $5 million is married with three children – two of whom work in the business.

Issue:  Upon death, the business will transfer to the two children.  However, the client wants to compensate fairly the child who does not work in the business.

Solution:  Since the first two children will inherit a $5 million business, we recommended that the third child become owner and beneficiary of a $2.5 million life insurance policy (with death benefit guarantee, of course).

Benefits:  The insurance is kept out of the client’s estate and will pass to the beneficiary tax-free.  In addition, the child outside of the business is satisfied and the other two children own the business with no contingencies or outside interference.

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Case Study: Life Insurance Trusts

Those of you with clients who have life insurance inside an Irrevocable Life Insurance Trust (ILIT) should have these policies reviewed for the following reasons:

1.  Many times, term policies are used – inappropriately – to fund an ILIT.  As you know, term insurance solves a temporary need while a trust is installed for a long-term/permanent issue.  When the term policy runs its course, the client may be left with unsettling options.

2.  Clients often fail to fund these policies adequately leaving the potential for the policy to lapse.  An in-force illustration will project the “life” of the policy and show any funding deficiencies.

3.  Some policies are purchased using inflated return assumptions and are especially in danger of lapsing if these rosy returns fail to materialize.  This often occurs with Variable Universal Life (VUL) policies. These polices should be carefully analyzed and monitored.

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Types of Lfe Insurance – and When to Use Them

Confused by all the commercials advertising life insurance? One says its for their kids’ college; the next one says they can’t be turned down for medical reasons; the next one says they have the lowest prices… It’s enough to make you turn the channel and want to forget you ever asked!

The objective of this article is to cut through the clutter and let you know what’s out there and when to use it. So let’s get started:
1. Life Insurance for College (or whatever) Funding. The “college funding” policy referred to in that very annoying Gerber TV ad (my wife and I can’t hit the “mute” button fast enough whenever it comes on) is nothing more than a simple whole life policy. Whole Life policies accumulate cash value on a very conservative (read: slow) basis. Since the policy “endows,” which means that the cash value should be equal to the face amount by the time the hopeful parents need it, the premiums will be very high. Also, life insurance has been marketed as a college-funding vehicle for decades so this idea is definitely not “different.”

2. Can’t be Turned Down for Medical Reasons. This is nothing more than Simplified Issue (SI) Whole Life Insurance. Since SI accepts basically everybody into its plan, the premium will be far higher than that of an individually-underwritten life insurance policy. If you are relatively healthy, you’d be better off going with a No-Lapse Guarantee Universal Life policy where the premiums will almost certainly be lower. Yes, you have to get a physical (called a paramed exam) but that’s nothing compared to the money you’ll be burning on an over-priced life insurance policy! Should we alert Alex Trebek?

3. Lowest Prices. This is the “holy grail” of the life insurance industry: get the most for the least. I am certainly not arguing with the concept (hence my website) but remember: there are trade offs with everything. If you want alot of life insurance for just a little money, then term insurance is for you. This is sometimes referred to as “pure insurance” as it only provides life insurance and nothing else such as cash value or lifetime guarantees. Also, the low premium generally expires after a certain period of time. For example, if you buy a twenty-year term policy, the premiums will remain the same for twenty years and then skyrocket to the tune of five to fifteen times what you were paying. The idea of term insurance, therefore, is to cover a temporary need such as a mortgage, the kid’s college or any other large debt.

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Common Estate Planning Mistakes – Third in a Series

As you have seen from previous articles, Estate Planning is fraught with pitfalls.  Many times, people will attempt to build their own estate plan but, unfortunately, don’t know what questions to ask.  My goal is to help you understand the issues that face even modest estates.

A.  Improper Disposition of Assets.  This occurs whenever the wrong asset goes to the wrong person in the wrong manner or in the wrong time-frame.  For example, leaving an entire, complex estate to a spouse who is unprepared or unwilling to handle it.  Leaving a sizable estate to a teenage is another good example.  The solution is to consider a trust or custodial arrangement and to provide in the Will for young or legally incompetent people.  Also, an often overlooked consideration is a “common-disaster” provision so that assets can avoid needless second probates and double inheritance taxes.

B.  Ensuring that your business is a Going Concern.  What happens to your business if a key revenue-generating employee dies or is disabled unexpectedly?  Do you have a “shock absorber” in place?  Key employee life and disability insurance coupled with good business overhead coverage will certainly help.

C.  Buy-Sell Agreements are essential if your business is to survive the death or disability of one of the owners.  Unfortunately, many business: have no such agreement; or the agreement isn’t in writing; or the price doesn’t reflect the current value of the business; or the agreement isn’t properly funded.  The bottom line is that the heirs are not guaranteed the fair market value to which they are entitled.  If you think you’ll skate by giving a grieving widow a value for her share that “the accountant came up with,” think again.  I know of many cases in which that kind of “solution” wound up being settled by lawyers.

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Personal Liability Insurance – Why It’s Important

The fact the we have  become a litigious society has not been lost on many people.  I remember the floodgates opened for this when some clutz spilled hot coffee on herself – and was awarded around $6 million dollars!  Instead of crawling under a rock out of embarrassment, this coordinationally-challenged individual stood our legal system on its head.  And that where it’s been ever since.  So, what can you do to protect yourself?  The answer begins with a simple Personal Liability Insurance policy.  Basically, Liability Insurance is designed to cover you for acts of negligence that create a legal obligation to a third party.

Personal Liability Insurance can be purchased as a “stand-alone” policy or it comes as part of the following coverages:

1.  Homeowner’s.  Here Personal Liability awards are payments that the individual is legally obligated to make because of bodily injury or property damage.

2.  Automobile.  Here Personal Liability awards are payments that the individual is legally obligated to make because of bodily injury or property damage as a result of an auto accident.

3.  Watercraft.  Personal liability payments cover pain and suffering, disfigurement, loss of mobility and actual medical costs.  In addition, it can cover damage or destruction of someone else’s property including loss of use.

The bottom line is that with an out-of-control legal system, you are well-advised to seek as much protection from it as possible.  For more information, go to: