Does shareholder insurance seem like such a confusing topic you don’t even know where to start? You’d have that in common with many other Canadians.
The ins and outs of shareholder insurance deserve a thorough explanation — which is exactly what we intend to provide in today’s post.
Let’s start with the basics.
What is shareholder insurance?
A business plan isn’t complete without a shareholder agreement containing buy/sell provisions, allowing for the orderly transfer of ownership interests upon disagreement, death, critical illness, or disability.
However, having to suddenly buy a partner’s shares can be very expensive.
Most business advisors agree that shareholder insurance is the most efficient means of providing buy/sell funding upon the death, illness, or disability of a shareholder.
How should the shareholder insurance be structured?
Who should be the beneficiary of the insurance policies for a shareholder agreement?
There are two options:
- The corporation can buy the insurance
- Each shareholder can purchase a policy on the other shareholders
Insurance premiums aren’t tax deductible unless required by a lender to protect a mortgage, loan, or line of credit.
This means it’s usually best for incorporated businesses to own the insurance at a corporate level, pay the premiums, and be the beneficiary.
Shareholder life insurance
It’s important to consider what happens if a shareholder dies.
In the event of a shareholder’s death, the remaining partners will be required to buy the shares of the deceased partner’s estate, continue the business in partnership with the deceased’ heirs, or fold the company.
Life insurance is the very best way to create cash to buy the shares of the deceased partner and continue with the business.
Here are two key types of life insurance to consider:
- Term Life Insurance – is the most basic premium structure, temporary insurance with the lowest initial premium. It is the least expensive initially but can be expensive to renew as premiums are tied to health and age.
- Permanent Life Insurance – premiums are higher initially but provides guaranteed coverage until death at any age.
Shareholder critical illness insurance
In the event a shareholder is diagnosed with a critical illness, the company will be paid a tax-free benefit in the form of a lump sum.
The company can use the money to hire qualified replacement personnel and/or limit the financial loss or decrease in revenue incurred resulting from the shareholder’s temporary or extended absence from work.
The company can use the money in any way they wish, including helping the shareholder get well by covering treatment costs and most.
Learn more about how much Critical Illness Insurance costs in Canada.
Disability insurance for shareholder buyout
Just as it sounds, disability insurance coverage is used to buy out the shares of a permanently disabled shareholder.
These policies are usually structured with a 360 or 720 day elimination period to be certain the disability is, in fact, permanent.
With this coverage, the remaining partners use the policy proceeds to continue business operations. They can also utilize the funds to hire a replacement to cover the workload and expertise of one of the disabled shareholders and then buy them out.
Key person life and health insurance
The death, illness or disability of a key person can cause a business great financial pain.
While a buyout may not be a concern, the lack of productivity, loss of specialized knowledge or relationships with key suppliers or customers should be a major concern.
It’s difficult to replace a key person, and even after they are replaced, it can take months or years before the new person can function at the same level as their predecessor.
Obviously, this is disruptive and creates issues with respect to profitability and efficiency.
That’s where key person insurance comes in.
Key person insurance can provide a company with the cash flow needed to cover the profits the key person would have brought into the company. It can also fill financial gaps while new employees are hired or trained.
The importance of business life and health insurance
Remember, business life and health insurance to fund a buy/sell agreement is just as important as the shareholder agreement, if not more so.
Shareholder life insurance, critical illness, disability and buyout insurance can save even small businesses from financial hardship.
In some cases, it can save the business itself.
As a business owner, you should consult with the appropriate accounting, legal, tax, and insurance advisors to ensure the planning is done properly.
It’s also essential for administrative/compliance issues to be addressed — and ensure everything is properly set up to keep your business running as smoothly as possible in the unfortunate case of the death or disability of a shareholder or key person.
At Shelter Bay Financial Corp., we’re experts when it comes to corporate insurance planning. Give us a call today at 1.888.498.5288.
This article was originally published on July 14, 2017, and has been updated.