Life insurance’s major role in business succession planning

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How often do you as a CPA think about life insurance matters as part of your role as trusted advisor to business owner clients?

If the answer is not very often, you should reconsider your position, because life insurance is a tool that, when used strategically, can address an array of difficult succession planning challenges. It’s also one that clients of CPA firms are finding increasingly valuable.

Succession planning is complex, confusing and laden with unique variables that include family dynamics, business-specific considerations, post-transition goals and more. On top of that, business owners must continue to run day-to-day operations and keep the business on a growth trajectory.

Yet, for many business owners, succession planning is top of mind these days — with good reason. Last year, there were 30.2 million small businesses in the U.S., according to the Small Business Administration, which represented 99.9 percent of all U.S. businesses. Those businesses are operating amidst an unprecedented generational transfer; indeed, there is a tidal wave of business exits on the horizon. Early baby boomers have reached retirement age – they’ve already started transitioning their businesses – and the tail end of this generation will get there in a few short years. Proper business succession planning requires at least an 18-month time horizon; if they haven’t yet begun planning for business succession, they’ll need to catch up fast.

Adding to this urgency is the reality that the temporary high exemption limit of $11 million will reset in 2026, or possibly sooner. Time also is needed for proper normalization of earnings, possible reduction of company expenses and redundant positions and services. Each of these affects EBITDA and, therefore, every dollar discovered could have a multiplier effect upon the final purchase price of the business.

For over 50 years, our firm has worked closely with CPAs and attorneys to provide the funding for succession planning, and life insurance is a valuable tool in this area. In my discussions with CPAs, I encourage them to ask their clients five fundamental questions up front:

1. What is your goal with succession planning? Cash in? Take some chips off the table? Stay active in the company for a certain period? Or have you’ve already chosen your successor, and now you’re considering ways to structure and fund the succession?
2. Is a buy-sell agreement that accounts for death, disability and retirement in existence? If so, is it signed? Has it been reviewed? Is it fully funded?
3. Are there insurance policies in place to meet the requirements of the buy-sell, and if so, when were they last reviewed?
4. Are there any pressing reasons to implement succession sooner rather than later – e.g., health, family, divorce, or money issues? Also, is there at least an 18-month runway available?
5. For succession planning, are you open to external succession, or are you looking internally only?

Whatever the case may be – internal sale, external sale, quick succession, gradual transfer – remember: Tax planning must drive the pre-transition process, implementation and the post-transition planning process. Succession plans and buy-sell agreements are constructed by attorneys, who, in most cases, are not tax specialists. They’re not educated and trained to focus on considerations like the taxable impacts of capital gains, retained earnings and more. Yet any type of succession strategy must be tax-driven — and you as a CPA must ensure that remains a strategic priority for each of your clients.

Once a client’s broader succession planning goals are established, I recommend to CPAs that they keep in mind three important components of life insurance as they pertain to succession planning:

1. Cash value. This can fund an initial down payment and can also be used for partial deferred compensation funding.
2. Death benefit. This is a guaranteed completion component of the agreement.
3. Disability trigger — specifically, how it will be funded. Various insurance products can provide guaranteed funding in the event of death and disability. We find the disability risk ignored in many cases, due to the lack of experience of specific products designed for succession planning. That said, every buy-sell agreement contains three triggers — be it death, retirement or disability. The question of disability becomes, how will that trigger be funded? In nearly every case I’ve encountered, the answer is achieved through specialty disability insurance products. In this regard, the devil lies in the details. Funding can occur via lump-sum, periodically over months or through other mechanisms, and each approach carries interesting taxable implications. Those must be understood up front by CPAs and their clients, and funding should be designed with tax minimization in mind.

Your clients look to you as their trusted advisor for advice, insight and counsel on a range of financial matters. When it comes to succession planning considerations, CPAs can and should be equipped to discuss matters related to life insurance with their clients and help direct them to the appropriate next steps. Having the ability to do so is crucial in strengthening the advisory role of CPAs on behalf of their clients.

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