Sooner or later, everyone wants to retire. But if you own a family business, retirement isn’t just a matter of deciding not to going to work any more.
Besides ensuring that you have enough money to retire on, a number of questions arise:
- What happens to the business when you’re no longer running it?
- Who’s going to manage the business when you no longer work the business?
- How will ownership be transferred?
- Will your business even carry on or will you sell it?
Succession planning seeks to manage these issues, setting up a smooth transition between you and the future owners of your business.
With family businesses, succession planning can be especially complicated because of the relationships and emotions involved – and because most people are not that comfortable discussing topics such as aging, death, and their financial affairs.
But comfortable or not, succession planning should be a priority for any family business.
More than 70% of family-owned businesses do not survive the transition from founder to second generation. In most cases, the “killer” is taxes or family discord, both issues that a good family business succession plan will cover.
We can help…
Let Ken and his RitePartner Resource Team lead you through the Business Succession Planning process. We can assist you in addressing all your questions and concerns to ensure a problem free transition.
More about Business Succession
Most often entrepreneurs spend years building a business and come to an agreement with a partner or family member over succession, but fail to make plans to finance the succession. This is where life insurance is used to insure the business owner and partners and provide the funds necessary to ensure the succession plans..
We recommend that business owners carry a Permanent, Universal Life or Term 100 insurance product because it lasts for your lifetime; whereas term insurance policy may expire or actually become unaffordable. Succession planning is a big issue for small companies and you need advice from someone, like Ken MacCoy, who understands the role of life insurance.
Capital Gains Exemption on Small Business Shares
The business succession planning process must include preparation for paying of estate taxes on the business. When a small business owner dies, an assessment is made on the value of the business. If it qualifies as a closely held corporation, there is no capital gains tax on the first $800,000 of value in the business. The tax-free amount may be offset by any capital business losses the owner declared in his or her lifetime.
We recommend that life insurance be used to cover the capital gains tax due and payable to CRA on the value of the business over and above $800,000. Depending on the structure of your succession agreement, you might use life insurance to allow a partner to buy out your share, an heir to take over or to provide an inheritance to a child who is not involved in the business.
How to Pay the Estate (capital gains) Taxes
You, as a sole proprietor, have built a business valued at more than $1 million. The plan is for your son to take over, but you are worried about estate taxes. When you die, your estate will owe taxes on the capital gain in the business. However, if there is not enough money in your estate to pay the taxes, your son may either have to: (1) Sell the business, (2) Liquidate assets, (3) Borrrow or take out a loan he cannot afford.
The logical and least expensive solution is a life policy on the sole proprietor sufficient to pay the taxes. The company owns the life policy and pays the premiums. When you die, the death benefit goes to a capital dividend account, minus the amount spent in premiums. The death benefit is used to pay the estate taxes, your son can take over the business and the excess goes to your wife. Your wife’s financial future is ensured and your son benefits from the new adjusted value of the business; which continues to grow.
Have a Partner? Get a Buy-Sell!
A similar arrangement is made between partners where a they sign a Buy-Sell agreement and fund the agreement with life insurance. Then, if one partner dies unexpectedly, the funds are in place for the surviving partner to purchase the shares of the estate of the deceased partner; and the deceased’s family has the money to pay the estate taxes.
Typically, the partners buy criss-cross insurance making each other or the company the beneficiary when they die. This way the money will be available to buy out the other partner. The widow or widower must sell to the partner and the money is there to cover the cost.
Key Person Insurance
Owners of small companies are often dependent on the expertise of a few top people. If a “key person” dies, it can hurt business. Key person insurance is there to protect against the financial loss of your best employee. If your key person dies before retirement, the business will use the money to go out and recruit someone of equal experience. The death benefit is used to cover such costs as hiring, a signing bonus or additional training.
What if the entrepreneur wants to retire, and turn the business over to a promising heir? How can he turn equity in his company into capital to fund his own retirement? Many small business continue to pay a salary to the retired owner of the business. The heir can slowly buy his shares, supplying a regular income. However, if he had a permanent or universal life insurance plan, now may be a good time to take the value out of that contract to fund his retirement.
Jack and Jill’s Business
Small businesses may not be worried about paying estate taxes, but they may wish to leave an equal legacy for each of their children when they cannot all be involved in the business. Jack and Jill have built a Mom and Pop business valued at $5 million. They want to leave it in the capable hands of their son, Junior, who has been a long-time participant in the business. But there is little outside the business to leave to their daughter, Lizzie who chose a separate career.
At their deaths, both Jack and Jill can claim their capital gains exemption of $800,000 each.. Their wills can specify that Junior inherit the business, but he will be required to pay fair market value for the business because it is not an arms-length sale; (more on this later). But both or either can take out insurance on themselves to ensure there is an inheritance for Lizzie. The policies would list Lizzie as beneficiary, and the money goes to her tax-free.
The amount of the life insurance policy does not have nor should it equal the full $5 million value of the business because Junior is inheriting something that requires a lifetime of hard work.