The Successful Business Owner. Strategies for effective business planning. Business Planning. insure invest retire

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1 The Successful Business Owner Strategies for effective business planning insure invest retire Business Planning

2 NOT A BANK OR CREDIT UNION DEPOSIT OR OBLIGATION NOT FDIC OR NCUA-INSURED NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY NOT GUARANTEED BY ANY BANK OR CREDIT UNION MAY GO DOWN IN VALUE The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. MassMutual, its employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.

3 You know what it takes to build a successful business. It takes vision, preparedness, skills and desire not to mention a focused dedication to achieving your goals. If you are like most business owners, you ve worked hard and made many sacrifices to grow your business. That s why you should put just as much energy into protecting it as you did building it. Ask yourself these important questions What is the plan for my business when I retire? Is my business capable of continuing its success in the event of my or my partner s untimely death or disability? Is my family adequately protected if something were to happen to me? Have I done everything I can to attract, retain and reward the key employees that are critical to my business? If you answered no to any of these questions, you may want to consider implementing a formal business planning strategy. Proper planning can help you protect your business, attract and retain key employees, and ensure that your business transfers in the manner that you choose. Life insurance is often a key component to an effective business planning strategy because life insurance provides valuable protection for business owners, their families, and their employees. Here s how: It can be used to enhance the standard benefits package for key employees to encourage loyalty to your company. It can help you protect your business financially in the event that one of your key employees dies. It can help ensure the proper transfer of the business in the event something unforeseen happens to you or a business partner. This brochure covers the many ways life insurance can help protect the longevity of your business and the people who are key to its success. 1

4 Attract & Retain Key Employees In today s highly competitive executive marketplace, it is becoming increasingly more difficult to attract and retain top talent. Salary is no longer the only compensation driver. These astute individuals also look at an employer s overall benefits package and its potential to help address their real concerns of financially protecting their families in addition to adequately planning for retirement. These concerns are heightened by ever-changing tax laws, pension plan uncertainties, and Social Security shortfalls. The good news is you can offer benefits that can make a difference for both your executives and your business. You probably already have a standard benefits package in place one that includes medical and dental coverage, disability income insurance, and a retirement plan. However, your competitors more than likely offer a similar benefits package. These days, employees are looking for special benefit plans above and beyond the standard packages most employers already offer. These benefits often provide the primary incentive for key employees to join and remain loyal to your company. The following describes some incentive benefit plans that you can offer to your key employees. What they all have in common is their ability to attract and retain key people. In addition, they may even be of benefit to the most important person in the business you! Nonqualified Deferred Compensation Plans (NQDC) NQDC plans are designed to provide extra retirement benefits for key employees above and beyond what can be provided with qualified pension, profit sharing, or 401(k) plans. You can choose which employees are to be covered, the amount of benefit to be provided, and whether the benefit is subject to a vesting schedule. In fact, you can use this type of plan just like it is used by large, publicly-owned corporations to reward and attract employees with golden handcuffs. NQDC plans are ideally suited to employers that: Want to provide additional retirement income to select, highly compensated employees. Have a stable, mature corporation that is likely to be in existence to pay the retirement and/or death benefit as promised by the NQDC. Have key employees who have maxed out their qualified retirement plans. These plans can be, and often are, supported by life insurance that is paid for and owned by the business. Life insurance is a safe way to provide income to key employees and their families. The living benefits from the accumulated cash value can be an effective way to fund retirement income for the employee, while the death benefit can be paid to the employee s family when the individual dies. In addition, the plan can be structured so that you recover the premiums you paid into the policy (requires a higher death benefit amount). The retirement benefit or death benefit is tax deductible to the company when paid out and taxable to the employee or his or her family when paid out as a salary continuation retirement benefit. 2

5 Split Dollar Plans Split Dollar plans are a cost- and tax-effective method of providing multiple benefits using life insurance. Split Dollar gets its name because it involves splitting the premium payments and policy benefits of a life insurance policy between you and your key employee. Here s how it typically works: You pay the premiums There are two types of ownership: Endorsements: You are the purchaser and owner of the policy and there is an agreement between you and the insured employee that defines the employee s rights to the policy. Collateral Assignments: Your employee purchases the policy and is the owner of the policy. The employee then makes a collateral assignment of the policy to you in return for you paying all or part of the policy premiums.* You are entitled to all of the policy s cash value When the employee dies, you can recoup the premiums you paid into the policy or receive an amount equal to the total cash value that s accumulated in the policy, whichever is greater. The balance of the death benefit is paid to the employee s beneficiary A split dollar plan is tax effective for the employee. Instead of paying full premiums with after tax dollars, the employee s annual cost is limited to a taxable economic benefit based on the employee s share of the death benefit. In addition, the death proceeds received by the employee s beneficiary are income tax free. *Cash value is a feature of permanent life insurance. 3

6 Executive (162) Bonus Plans An Executive, or 162, Bonus Plan is a type of incentive plan where the business provides an executive with funds that are used to purchase a life insurance policy owned by the employee. Your business pays the life insurance premium directly or indirectly through a salary bonus. You can choose which employees receive this incentive, but the employee has full access to the policy s cash value and he/she chooses the beneficiary. Executive Bonus Plans are recommended when: A key employee has a need for life insurance. You are looking for additional tax deductions. You need to provide key employees with a benefit in addition to a qualified retirement plan. The bonus amount you pay is fully tax deductible to the company, provided this is considered reasonable compensation, and taxed as ordinary income to the employee. You have the option to work out an arrangement with the employee, such as offering a loan, to help cover the income tax liability. Qualified Retirement Plans including 412(i) 1 Depending on the size of your business and plan objectives, MassMutual offers products and services for tax qualified retirement plans, such as 401(k), profit sharing, and 412(i) plans. Specifically, a 412(i) plan is a qualified defined benefit pension plan, funded exclusively with fixed annuities or with a combination of fixed annuities and level premium permanent life insurance. A 412(i) plan may provide larger federal income tax deductions than other types of plans and are generally used by businesses where the owners are above age 50. Additional Insurance Options Oftentimes, business owners overlook the opportunity to make other types of insurance available to employees in packages along with life insurance or the plans previously discussed. Disability Income Insurance, for example, can be another important benefit. Nearly half of small owners believe that the likelihood of an employee becoming disabled is one in 50. The actual likelihood, according to the American Council of Life Insurers (ACLI), is one in three (i) has been renumbered 412(e)(3) by the Pension Protection Act of Source: American Council of Life Insurers (ACLI), 2003.

7 Long-term disability income insurance can have tax advantages and can be made available to key employees only or to all employees. The employee would own a disability income insurance policy with waiting and benefit periods suitable for his/her own circumstances. You pay the premium, which may be tax deductible. Generally, the premium is not taxable income to the employee; however, if disability should occur, the benefits are then taxable to the employee. You can choose to allow the employee to include the premium as part of their reportable income, which would result in a tax free disability benefit. Protect the Business You ve Worked So Hard To Build You ve built your business with the hopes that it will withstand the test of time. Unfortunately there are a lot of elements out of your control that can affect the success of your business, such as an unstable economy, a lack of consumer spending, and increased competition. Think about what would happen to your business if you, your business partner, or a key employee were to die unexpectedly. There s no doubt that this would also have a huge impact on your business and its continued success. But there s good news: this is something you can plan for. Key-Person Insurance Key person insurance can help offer peace of mind in knowing that the financial stability of your business is protected in the event of a valued employee s untimely death. Basically, you purchase a life insurance policy to cover the life of that individual, naming your business as the beneficiary. If the key employee dies, the policy proceeds are paid back to the business to help keep it going while you seek to fill the void left by the deceased employee. 3 This arrangement is ideally suited for businesses with: Owners, partners or executives that have a direct impact on company earnings. Salespeople who continually exceed goals or have relationships with important clients. Individuals who have specialized skills or technical knowledge that cannot easily be replaced. Premiums for key person insurance are not tax deductible since the business is the beneficiary of the policy, and may be subject to Corporate AMT. However, the death benefit proceeds are typically exempt from federal income tax. It s also important to note that accurately assessing the key person s value to the business is critical to make certain adequate funds are available when they are needed most. The following are some common business planning strategies designed to protect your business. Just as you would insure your business property, you should also consider insuring the people who make the biggest impact on your company s success. 3 Death benefit may be subject to Alternative Minimum Tax (AMT). 5

8 Buy-Sell Agreements As part owner of a business, one of your primary concerns should be to ensure the continuity of the business should you or one of your partners dies. With a buy-sell agreement one party is obligated to purchase a deceased business owner s interest in the business at a certain price, and another party the deceased owner s estate or heirs is obligated to sell the interest at that price. By establishing a buy-sell agreement, you can help ensure a smooth transition of ownership, with minimal disruption to the day-to-day activities of the business. An effective buy-sell agreement must establish: Who will purchase the decedent s share of the business. At what price the decedent s heirs or estate will sell the share. When the sale will take place and how it will be funded. In a Cross-Purchase Buy-Sell Plan each business owner purchases a life insurance policy covering the life of every other owner. Each business owner pays the premiums and is the beneficiary of the policies that he/she is purchasing. If an owner dies, the surviving owners use the life insurance death benefit to purchase the deceased owner s interest. In an Entity/Stock Redemption Buy-Sell Plan the business purchases life insurance policies on each owner. The business pays the policy premiums and is the beneficiary on each policy. If one of the owner s dies, the death benefit from his/her policy is paid to the business to purchase that owner s interest in the company. The chart on the following page provides some guidance to help you determine which buy-sell plan may be most suitable for your business. There are two types of buy-sell agreements, both utilizing life insurance. Under both types of arrangements, the total amount of insurance should approximate the anticipated purchase price of the insured s share of the business. 6

9 Factors in Determining the form of Corporate Buy-Sell Agreement FACTOR Number of parties Age and ownership differential Life insurance funding Cost basis Attribution of ownership rules Possibility of plan change Tax considerations Tax bracket CONSIDERATION The larger the number of parties, the more complex the establishment and administration of a cross-purchase plan will be. This would include a far greater number of insurance polices if that was the funding vehicle. The greater the age difference, the larger the financial obligation imposed upon the younger/minority stockholder or partners, under a cross-purchase plan. An entity plan may be preferable since it allows for a pooling of the premium obligations within the business (corporate dollars). An entity purchase plan would not necessitate the business owners personally paying premiums for funding life insurance. However, split dollar life insurance may assist in funding a cross-purchase. Since a cross-purchase plan generally will result in the surviving owner receiving a higher cost basis for the business interest, the survivor would incur lower capital gain for any subsequent sale. Due to potential dividend taxation under Internal Revenue Code Section 301, redemption may be inadvisable for a family corporation. Therefore, a cross-purchase plan may be the only viable approach. If the parties anticipate that they may change from one type of plan to another, the effect of the transfer-for-value rule {Internal Revenue Code Section 101 (a)(2)} favors the initial establishment of a cross-purchase plan for a corporation, since the policies could later be transferred to the corporation to fund a redemption without creating a transfer-forvalue. However, the parties normally would not be able to transfer the policies from the corporation to the non-insured stockholders to fund a cross-purchase plan, without creating a transfer-for-value and, therefore, subjecting the death proceeds to income taxation. Funding a stock redemption agreement requires attention to be paid to possible accumulated earning tax and the corporate alternative minimum tax. A cross-purchase plan can ignore these concerns. If the corporate tax bracket is higher than the policy-owner s individual tax bracket, a cross-purchase arrangement would be the logical choice and vice-versa. 7

10 Protect Your Most Valuable Asset Life insurance is often the foundation of a sound business planning strategy. Most business owners find that permanent insurance including whole life, universal life and variable life suits their needs best. That s because it: Is structured to provide lifetime protection benefits Can be obtained on a low cost-to-earnings ratio Accumulates cash values that can be recordable assets for your business 3 Can provide some tax advantages in certain situations It s also important to keep in mind that your business is your second most valuable asset. The death benefit in a life insurance policy can also help ensure that your family s financial well-being is protected in the event you or your business can no longer provide the income you are accustomed to. Whether you ve just started thinking about an employee benefit and business continuation plan, or already have some strategies in place, Massachusetts Mutual Life Insurance Company (MassMutual) offers a variety of financial products and services to meet your particular needs. Talk to your MassMutual financial professional about designing a plan to help protect and ensure the continued success of your business. After all, if it was a business worth building, then it s a business worth keeping. MassMutual. For over 150 years, MassMutual and its affiliated financial professionals have helped guide our policyholders toward greater security and financial freedom. Our commitment is to help you focus on what you value most, clarify what you want to achieve in life, and understand how life s uncertainties could impact your plans and aspirations. After all, it s not about where life takes you it s about where you take life. Built on a foundation of integrity, strength, and reliability, MassMutual can help you get there. One measure of a company s value to its customers is its financial strength. MassMutual s exceptional financial strength is underscored by ratings that are among the best in any industry: A.M. Best Company A++ (Superior) Moody s Investors Service, Inc Aa1 (Excellent) Standard & Poor s Corp AAA (Extremely Strong) Fitch Ratings AAA (Exceptionally Strong) This information is current as of October 1, Ratings are subject to change. Ratings are for Massachusetts Mutual Life Insurance Company, C.M. Life Insurance Company and MML Bay State Life Insurance Company.

11 We ll help you get there.

12 Massachusetts Mutual Life Insurance Company and affiliates, Springfield, MA Securities offered through registered representatives of MML Investors Services, Inc., 1295 State Street, Springfield, MA Massachusetts Mutual Life Insurance Company. All rights reserved. MassMutual Financial Group is a marketing name for Massachusetts Mutual Life Insurance Company (MassMutual) and its affiliated companies and sales representatives. LI CRN