Category: Small Business

Jun

Why Do I Need Key Person Life Insurance for My Business?

How to Protect Your Business, Profits, and Livelihood with Key Person Insurance

Every firm should consider the impact of suddenly losing a partner or key employee. The unexpected death or disability of a key member of your staff can cripple your operations. Along with losing a valued member of your management team, you would also be losing the manager’s skill, “know-how” and, perhaps, the important business relationships he or she had cultivated over the years.

Navigating the Shoals
Although it is impossible to prevent the sudden and unexpected loss of a critical employee, you can receive compensation through insurance to protect against the loss of a key person. A key person policy covers or “indemnifies” a company against the loss of a valued team member’s skill and experience. The proceeds help: provide funds to recruit, hire, and train a replacement; replace lost profits; assure customers that business operations will continue; and reassure lenders that funds will be available to help repay business loans.

Generally, the firm owns the policy, the premiums are not deductible, and the death proceeds are received by the company income tax free, although there may be alternative minimum tax (AMT) consequences for businesses structured as C corporations.

Charting a Course
Needless to say, it is not easy placing a value on a key employee. Generally, there are three different approaches used to determine the amount of insurance that is necessary:

The “multiple” approach uses a multiple of the key person’s total annual compensation, including bonuses and deferred compensation. The popularity of this method may reflect the difficulty business executives have in quantifying a key employee’s value. On the other hand, the disadvantage is that the estimate, typically for five or more years’ annual compensation, may or may not relate to actual needs.
The business profits approach is a more sophisticated method. It attempts to quantify the portion of the business’s net profit that is directly attributable to the key person and then multiplies that amount by the number of years it is expected it will take for a replacement to become as productive as the insured. For example, if net profit attributable to the key employee is estimated at $250,000 annually, and it is expected that it would take five years to hire and train a replacement, then the policy’s face amount would be $1.25 million.
The present value approach calculates the present value of the profit contributions of the key employee over a specified number of years. This amount is then used as the face value of the policy. For instance, with an anticipated profit contribution of $250,000 per year for the next five years and a discount rate of 8%, the policy’s face value would be about $1 million. This method assumes insurance proceeds can be invested at a given rate of return and will be expended over a given period of years.

Regardless of which method is best suited for your practice, key person insurance is a vital component in protecting your firm from the loss of your most valuable assets—the people who help it grow and prosper.

Disclosure: You should consult with and rely on your own independent tax and legal advisors regarding your particular situation and the concepts presented herein. Eddy Financial, LLC does not provide tax or legal advice. Although care has been taken in preparing this material and presenting it accurately, Eddy Financial, LLC disclaims any express or implied warranty as to the accuracy of any material contained herein and any liability with respect to it. Eddy Financial, LLC is not a licensed insurance entity. Insurance services are offered through Andrew Eddy, an individually licensed life insurance agent in the state of California. Andrew Eddy’s California Insurance License is № 0K02163.

Apr

10 Tips for Small Biz Owners

Small businesses owners should conduct an annual assessment of their personal finances. Owners of small businesses have much the same concerns as everyone else, except they are personally responsible for the fortunes of their enterprise. In a sense, a small business is like a family. And these are important families in American economic life. After all, small business is vital to the U.S. economy, employing half of private-sector workers and creating two-thirds of net new jobs, according to federal data.

Here are 10 tips to follow in weighing a small business owner’s financial plan:

Budget/Saving. A general financial planning suggestion is that you should save AT LEAST 10% of your income on an annual basis. You should also review short-term and long-term goals to ensure you are saving enough to meet your objectives.

Maximize Contributions to Retirement Plans. Depending on the size of the company and number of employees, there are many different methods to save for retirement. On an annual basis, business owners should work with their accountants/advisors to determine the most appropriate savings vehicle. Retirement plans include: 401(k)s, individual 401(k)s, individual retirement accounts, Simplified Employee Pension (SEP) IRAs, Roth IRAs, defined benefit and defined contribution plans. This will not only help achieve the goal of saving 10% of your income, but it also can help minimize taxes.

Create/Review Estate Planning Documents. It is important to create wills, living wills, medical and financial power of attorney documents. These documents should be reviewed annually as your personal goals and estate laws change.

Life Insurance. Various types of life insurance are available, including permanent and term policies. They provide a death benefit when the owner of the policy passes away. It is important to review your policies yearly to ensure the coverage is adequate to protect your loved ones. Also, financial situations may change.

Disability Insurance. Statistically, you have a greater chance of premature disability than premature death. Therefore, it is very important to own adequate coverage to provide for you and your dependents if you are not able to work. Annually, you should review your policy for the type and amount of coverage.

Business Insurance. As a business owner, it is important to own insurance that will allow your company to run if you are unable to actively participate in its daily operations. This insurance may be used to hire a person to substitute for you, or to replace income from your business if the company no longer exists.

Long-Term Care Insurance. Due to the increasing costs of health care, long-term care insurance policies are evolving to deal with them. LTC policies not only include traditional annual premium type policies, but new types of policies that enable lump sum payments and life time riders.

Education Planning: 529, Coverdell, Uniform Gift to Minors Act (UGMA), Uniform Transfer to Minors Act (UTMA) Plans. Much like health care costs, college education expenses have increased well beyond average inflation levels throughout the past decade. Several college savings vehicles are available to provide tax advantages and an array of investment options for college saving. These savings plans require thorough annual review of performance and expense levels.

Tax Planning. Annually, you should meet with your accountant to discuss tax-planning strategies. Tax laws frequently change. In addition, there may be changes to your business that could affect your taxes both at the business and individual level.

Investment Allocation. Review your entire investment portfolio to ensure it is allocated to meet your current and future goals. As your goals and needs change, your portfolio allocation should be readjusted accordingly.

Oct

Don’t Be Like Sears – Lessons Learned

Lesson from the Death of Sears, Roebuck and Co.

Diversification is not asset allocation

In 1886, Richard Sears bought a shipment of gold watches that had been rejected by a local jeweler, sold them at a profit, ordered more and then founded the R.W. Sears Watch Company in Minneapolis. The next year, he partnered with Alvah Roebuck, moved to Chicago and in 1893, Sears, Roebuck and Co. was born.

Sears went public in 1906 in the first IPO for an American retail company and the first IPO handled by Goldman Sachs. Under the stock symbol “S,” Sears was a member of the venerable Dow Jones Industrial Average from 1924 to 1999.

In the 1930s, Sears created Allstate Insurance Company and began placing Allstate representatives in its stores in 1934. Over the years, Sears established a number of major brands, including Kenmore, Craftsman, DieHard and Toughskins. Throughout most of the 20^th century, Sears was a true conglomerate, owning Dean Witter Reynolds and Coldwell Banker and launching the Discover Card in 1985.

Socks and Stocks

In the early 1980s, Sears bought Dean Witter Reynolds, and under Sears it grew to become the third-largest brokerage firm in the U.S. with over 9,000 account executives serving over 3.2 million clients with total assets under management over $90 billion.

With this acquisition came a new “socks and stocks” strategy, which was an effort to expand their financial services offerings beyond its existing insurance business.

What Killed Sears

Sears filled for bankruptcy on Monday, October 15th. So, what happened to cause this 125-year-old company to fall so far?

Typing in the phrase “what killed Sears” in a Google search will turn up over 12 million hits and lots of explanations for the demise of this one-time giant. At the top of the list is usually Amazon, but one will also find articles with inflammatory titles like:

Retail Hubris;
Walmart, Home Depot and Target Killed Sears;
Blame the Sears Retirees;
The Most Hated CEO in America; and
Ayn Rand Killed Sears

The reality is that there were lots of reasons for the demise of Sears. But instead of trying to answer that question, there is one very important lesson that investors would be well served by remembering:

Diversification is Not Asset Allocation

The question of how we array our investments is vital to our future financial well-being. Key to this is knowing the difference between asset allocation and diversification.

Some think that asset allocation and diversification are the same. They are not. An investor may have excellent diversification but poor asset allocation and vice versa. To keep unnecessary risks to a minimum, we need both.

Let’s start with asset allocation. This refers to the actual act of investing in different categories of investments, called asset classes. That is, we pick which assets we want to have in our portfolio. Generally, investors choose from stocks (equities), bonds (fixed income), cash, commodities and real estate.

Diversification, on the other hand, is the process of balancing these classes and within these classes so they offset one another amid ever-changing market conditions.

A Simple Example

Suppose an investor buys one single stock, one bond, holds one dollar, one ounce of gold and owns a home – this is an example of a decent allocation across most of the asset classes. However, the diversification is terrible.

Assume we have a total of $100 ($20 each) in the five asset classes. If the company issuing the stock goes bankrupt, we immediately lose 20% of the portfolio and now hold a total of $80. This, of course, assumes that the rest of the market does not change.

The following year, the company that issued the bond defaults on its debt and cannot repay the bondholders. Now, our portfolio is worth only $60, a 40% loss in two years. The next year gold doubles, as does real estate, which brings the portfolio back to a total of $100 ($40 in gold, $40 in real estate and $20 in cash). We are back to where we started financially but with fewer asset class categories.

Then, stocks and bonds soar. Since we lost our stock and bond exposure when they tanked, we miss a huge opportunity. Not to mention that cash actually lost money (purchasing power) due to inflation.

As an alternative, if we still choose the same asset classes, but diversify within those asset classes, we have more protection against market volatility. For example, we don’t choose just one stock, but several hundred through mutual funds divided among small-capitalization, mid-cap, large-cap and international mutual funds. Similarly, instead of one single bond, we consider holding short-term, intermediate and long-term fixed-income mutual funds. The same is true for commodities (not only gold, but natural resources, silver, etc.) and real estate – we consider mutual funds.

The Final Proof Point

Richard Sears was born into a relatively prosperous family in 1863. His father was a blacksmith and wagon-maker, but he lost all of his money – about $50,000 – in a failed stock-farm venture.

Don’t be like Sears.

Disclosure: There is no assurance that a diversified portfolio will produce better returns than an undiversified portfolio, nor does diversification assure against market loss.

Oct

4 Reasons Small Business Owners Need to Consider 401(k) Plans

401(k) Plans – A Nice Fit for Small Business Owners

Qualified plans, such as a 401(k) plan, offer excellent benefits for small business owners. These plans can provide a multitude of tax advantages that combine to deliver far more tax leverage than most people may imagine. Here is a list of the advantages a 401(k) plan may provide for your company:

Within the limits of the present tax and ERISA (Employee Retirement Income Security Act) rules, the business receives a current income tax deduction on contributions to the plan and the individual employees are not taxed on plan contributions made on their behalf.
Improving employee benefits will provide an advantage when seeking to recruit and retain good employees. Often, a significant amount of the contribution for the employee’s benefit has been realized as a result of corporate after-tax income savings to the plan.
Plan funds will accumulate on a tax-deferred basis.
At retirement age, individuals are provided with favorable tax treatment on the plan distributions. They may, for example, use their interest in the plan to fund an annuity to fit their retirement needs and be taxed on the income only when received.

The Bottom Line

While an obvious advantage to a 401(k) and other qualified plans is the ability to take a deduction today and postpone paying taxes until tomorrow, it is clearly not the only advantage. Even more important is the ability to invest employee retirement funds on a tax-deferred basis. As a result, whether tax rates remain the same or increase, a 401(k) plan remains a valuable tax planning tool for small business owners.