Why Corporate Owned Life Insurance is Essential in an ESOP

by | Feb 14, 2018 | ESOP

An infographic depicting the project management process, likened to the ESOP planning process. Four interconnected circles labeled "Design" (orange), "Develop" (green), "Analyze" (red), and "Evaluate" (blue) are connected by arrows, forming a continuous cycle. "Project Management Process" is in the center.

An ESOP (Employee Stock Ownership Plan) is a unique vehicle for owners and employees.  An ESOP offers a flexible, tax-favorable way for owners to exit their business and provide retirement benefits and retain and motivate employees.

ESOP’s are popular. In the U.S. there are approximately 11,500 ESOP’s, covering about 10 million employees (about 10% of the workforce).

As Doug McClure, CEO of Global Investment Strategies explained: “Establishing an ESOP is a great step towards financial security for owners and employees.  The last thing they want is to see sustainability of the company and ESOP derailed by unplanned or even planned events.”

To guard against these pitfalls, Doug emphasized the versatility and importance of a well-planned life insurance strategy as part of the overall ESOP strategy. Corporate-Owned Life Insurance solves several potential problems, and protects cash flow, profits, and the long-term sustainability of the company.  Specific uses of Life Insurance within an ESOP include:

Repurchase liability – an ESOP is a retirement plan for employees, and they will eventually retire (or depart, or unexpectedly die). Life insurance is a solution for accumulating the funds needed to cover these retirement expenses when they occur.  Of note, 18% of ESOPs fail because of not planning for the funding of repurchase obligations.

Key Person Protection – the death of an individual critical to the company’s success can place a big financial burden on an ESOP owned company. Life insurance on that person provides peace of mind by assuring resources to meet creditor demands.

Loan protection – Life insurance owned by the business can be collateral to secure a loan, with an assignment to the lender that some or all the death benefits will be used toward the loan.

Buy-Sell planning – with multiple owners, life insurance in the event of total departure, death or disability can make sure funding is available for the continued growth and stability of the company.  Specifically, in case of death, the Life insurance is used to purchase the stock from the estate of the departed employee providing the family money in their time of need.

Income and estate tax planning – an ESOP is also another exit strategy for the owner. There are capital gains considerations for the owner when they sell their stock to the ESOP. Life insurance held in an irrevocable trust can help with these estate tax issues.

An ESOP benefits all parties. Current owners protect the legacy of what they built and have a solid exit strategy. The company’s cash flow improves, productivity improves, and attracting quality new hires improves. Employees are motivated to sustain this and secure their own retirement.

Corporate Owned Life insurance ensures all of these benefits.