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Life insurance for small biz partners: Do you need it?

Small business partners

You and your partner have built a thriving small business. But what if you partner should suddenly die? Would you be able to replace the income that your partner generated? Would you have enough money to buy out your partner's portion of the business?

Or would your partner's death jeopardize the business you've worked so long to build?

These are serious questions, but ones that too few business owners consider. It's not surprising. Business owners are notoriously busy, and running a business takes time and energy. And who wants to think about their partner suddenly dying?

Enter life insurance for small business partners

Fortunately, partners can protect their businesses by taking out life insurance policies.

Say your partner dies. If your partner named you as a beneficiary, you would receive the financial death benefit. You could then use that money to buy out your partner's share of the business. You could use the benefit to keep your business running as you search for a new partner. Or you could rely on the death benefit as a quick infusion of cash to make up for any lost income that will result because of your partner's death.

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If you die, the same thing would happen: Your death benefit would go to your business partner, so that your partner could buy out your half of the business or use the funds to keep the business operating after your death.

Life insurance, then, is an investment that small business owners need to seriously consider.

Don't forget life insurance for your family

It's important, though, to not shortchange your family members. Yes, life insurance that would protect your small business is a sound financial investment. But you also need to make sure that you are carrying enough life insurance protection for your spouse and children, too, should you die.

The simple rule is this: Protect your family first. Then look at the financial needs of your business and take out a second life insurance policy after you've already invested in a main policy for your family.

Two choices: Term life and permanant life insurance

You and your business partners have two choices when it comes to business insurance: term life insurance and permanent life insurance.

1. Term life insurance: Term life insurance is the more affordable but – as the name suggests – less permanent option of the two. With this type of insurance, you are buying protection for only a certain number of years. You might pay for a term life policy that lasts for 20 years and pays out $700,000 on your death.

Say either you, your partner or both of you plan to retire from the business in 20 years. You can then take out a 20-year term life policy that will pay out a death benefit if one of you die before that. This could be an economical solution because term life premiums are less expensive than those connected to permanent life insurance policies.

But there is a downside. If you and your partner don't retire after 20 years and your initial 20-year term expires, you face a potentially expensive choice. You can either let the policy lapse, receive no payout and be without life insurance coverage, or you can elect to renew the policy. But the premiums you’ll have to pay upon renewal will almost certainly be higher because the cost of term life coverage increases the older you get.

2. Permanent life insurance: Permanent life insurance -- often called whole life insurance -- is your second choice. A permanent life insurance policy lasts for your entire lifetime and pays out a benefit when you die. As long as you keep making your payments, this type of insurance will not lapse.

This might make permanent life insurance a sound choice for business owners. When buying life insurance to protect your children, you usually know that you won’t need this protection when your sons or daughters reach adulthood. Because of this, a term life insurance policy often makes sense. You don’t know, though, how long you and your business partners will want to remain co-owners of your small business. A permanent life insurance policy can provide protection that lasts as long as you want it to. You won’t have to take a chance that your insurance policy will expire sooner than you’d like.

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Permanent life insurance also comes with an investment component, often referred to as the "cash value" portion of the insurance. When you pay your premiums, some of the money is funneled into a savings account attached to your insurance. Your insurance company then pays interest on that money so that it grows over time. When you die, your beneficiaries receive both the death benefit and the money in this savings account. You can also borrow against the cash value portion of your policy if you need extra cash to help fuel your small business.

There is a downside to permanent life policies, though: They are more expensive than term insurance. Some financial experts recommend taking out lower-cost term life insurance and investing the money you save in lower premiums in interest-bearing savings vehicles.

Bottom line: Have the discussion with your business partner

No matter if you prefer permanent or term life insurance, the key is to discuss this type of protection with your business partners before it’s too late. You don’t want a partner’s death to send your business into a financial spiral.

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