Whole Life Insurance… these three words don’t fit right in my head. Actually, the last two words are fine, but I would rather switch the word “whole” by “term” usually ;-). I’ve rarely spoken about my insurance structure on this blog. In fact, the last time I discussed my own life insurance structure was back in 2007! Since then, I’ve upgraded my life insurance structure according to our needs. I’m actually going to tell you more about my personal life insurance structure in another post. Today, I want to concentrate on explaining why I chose a whole life policy to cover a part of my needs.
Hint: if you are an entrepreneur, you want to read this post.
A whole life insurance policy is quite easy to understand:
- You pay X amount of premium per year to get your contract.
- This contract insures you for X amount in the event that you pass away.
- The contract is good for your life.
- If you pay more than the premium, you have the possibility to invest in a tax-sheltered account (let’s say that your monthly cost is $100 and you pay $125, there is $25 being invested in a tax-sheltered account called Cash Surrender Value).
The major downside of whole life insurance is that it’s quite expensive (and brokers are making a lot of money on them! Hahaha!). This is why brokers tend to push this product down your throat based on the fact that they will make more money you need life insurance coverage for your entire life. This is definitely not the right way to get cheap life insurance if this is what you are looking for ;-)é
Technically, your insurance needs are a lot higher when you are younger than when you are 70. So being insured for 500K at the age of 70 is quite useless. Unless you want to play Santa Claus, nobody really needs this money. So in 90% of cases, you are much better off with term life insurance that will cover your needs for a specific period of time. For example, most of my life insurance coverage is in a term life insurance that will last for the next 20 years. After that period, I won’t need much coverage since all my kids will have finished school, my house will be almost paid off, I will have RRSPs and a pension plan big enough to cover my wife’s financial needs. So why would I pay for an expensive whole life policy that will only make my kids rich? But still, I do have a whole life insurance policy… of $250,000!
Okay… but Mike, why the hell have you taken a whole life insurance policy then? Are you that dumb???
Bear with me for a moment, you’ll understand.
There are two things you can’t avoid inCanada: Death and Taxes! The problem is that both of them are quite related. In fact, if you ever pass away, you are considered to have sold all your assets the second prior to your death for tax purposes. Therefore, if you can’t roll your assets to your spouse, there will be a huge tax implication to be paid by your Estate. This is the first reason why you need life insurance if you own a company. This insurance need is there today, but will also exist in 40 years from now. This is why I need a whole life insurance policy that will cover this risk. Since I can roll my company shares to my wife without tax implications, there is another reason why I needed insurance.
I have a partner.
Having a business partner is clearly amazing. It enables the both of us to grow something much bigger in less time. But this also means that I don’t hold 100% of my company shares. If my partner would pass away tomorrow morning, his 50% of the company shares would be transferred to his wife. While I really like his wife and we are very good friends, I doubt I would like to manage “my” company with a different partner. So the easy way would be to buy her shares. But since we valued our company at $263,042 this year, I would need to spit $131,500 to buy back her shares. I obviously don’t have this liquidity!
Without insurance, this could create a big mess. Imagine if his wife would like to receive a dividend of $1,500 per month? Or that she would like to sell half of our sites to get a big fat check? The fact that we each hold 50% of the company would completely freeze the company and would make it very difficult to operate. On my side, I wouldn’t be able to continue growing it as I want and I would not have the liquidity to hire someone to replace my partner’s expertise (remember, I’m a techno retarded blogger, I can’t run this company by myself since I don’t even know what html and php means!). This is where the whole life insurance policy could become your best friend!
In order to be able to buy back my partner’s 50%, we both agreed to purchase a $250,000 whole life insurance policy. We are both insured by the same contract (which means that if I die, my partner will receive the $250K and vice-versa) and we have selected a “first-to-die” clause. The first to die clause enables us to both be covered for $250K but the payment occurs only once. Therefore, the first one to pass away will trigger the $250K payment from the life insurance company. The second to pass away won’t trigger anything more.
Our goal was to take an insurance policy that would enable us to buy our partner shares upon death and generate some liquidity to hire someone to cope for the loss of the partner in the daily activities. This is why the amount of $250,000 is much bigger than the actual value of the company. After paying the shares, we need a few thousand to operate the company.
Since this insurance need will exist until we sell the company, we couldn’t go for a term life insurance of 20 or 30 years. In 30 years, we will still need that cash to buy our partner shares. This is why the whole life insurance was the best bet for us. It guarantees us to be able to operate our company and it guarantees also that our wives receive something coming from the company.
It is very possible that we will have to increase the amount of coverage later on. When we started, the company wasn’t worth that much and the amount of $250k covers a company value of $500K. We are already halfway in this valuation after three years. I guess that we will hit the $500K value in a few years. At that time, we will probably take the option to invest in the cash surrender value. By increasing the payment of our premium, we will be able to not only invest in a tax-sheltered investments, but this will also grow the amount of our whole life insurance policy.
For example, if we pay $100/month for our $250K coverage, we could decide to invest $100 more and increase our payment to $200/month. At that time, we would be investing and additional $1,200 in the policy. Therefore, at the end of the year, we would be having coverage of $251,200 instead of the previous $250,000. The other option would be to write another whole life insurance contract for an additional amount. Depending on the cost of the insurance, the cash surrender value investment could become more interesting.
In the end, the most important thing is to make sure that we have enough coverage to keep the company rolling and to make sure that our wives get the part they deserve in this story. I’ve seen families being torn apart after the death of a rich individual, I won’t let this happen. All I need is a whole life insurance and this problem will never happen!
This post about insurance is linked to the Insurance Movement initiated by Jeff @ Good Financial Cents. Check out his site, he is offering cash rewards!!! Insurance is so important, but most people are not properly insured. This is why Jeff decided to raise this movement. You can read other articles about Life insurance here:
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