Armando (0:00 – 1:45)
Well, hello, founder, you built your business over decades, and now it’s time to think about that once in a lifetime exit from your business. You’ve come to the right place here. You will hear business exit professionals involved in the buying and selling of companies talk about what you should know before you exit your business.
If you’ve never sold a business before, this podcast can be super helpful to you. You will come away with an understanding of a successful business exit. Done right.
I’m Armando, host of the Founder’s Guidepost. Enjoy. But first, a quick disclosure.
Opinions expressed are those of individual professionals. The Founder’s Guidepost is a service of Axiom Founder’s Family Office, Inc., a registered investment advisor licensed or exempt from state registration in all states in which it operates. The Scottsdale Founder’s Forum is a biannual live event for you, the founder, considering exiting your business in the next 36 months.
More information available at ScottsdaleFoundersForum.com. Hello, this is Armando with the Founder’s Guidepost. And with me today is Mike Olson from WealthPoint, a founding partner of WealthPoint.
And Mike, I’m going to give you a quick introduction and ask you to fill in some of those blanks so that as people are are hearing this conversation and watching that they get a better sense of who you are, what you do and how you can help them with their business. So with WealthPoint, when I think about you, I think about risk management, but that’s such a broad category of what that really means. And I think about life insurance and how it fits in place.
But let me ask you if you could just to fill in some of those gaps about who you are, what you do, what WealthPoint is. And then let’s have a conversation for that founder of the business.
Mike (1:46 – 3:08)
Perfect. Thank you. So the mission of WealthPoint was to have a source for individuals like yourself, CPAs, attorneys, wealth advisors to go to to help business owners kind of enhance the creativity and value proposition of how to help business owners kind of take care of some of those outstanding issues that sometimes get neglected.
Right. And we have two kind of expertise. One is the life insurance industry.
And we happen to have a business consulting group on the side. But why that’s important is all that knowledge from the business side translates into the insurance side. So the ability to help business owners really when you say risk management, look at their business and how it’s growing in value and how do you take advantage and protect the family, the partners, key people, all those kind of things, that process.
And WealthPoint’s mission is to do that in a very fiduciary behavioral model, not a sales system. So working very collaboratively with the use of the world to explore options, to analyze options, to educate, to get the best possible solutions brought to the table.
Armando (3:09 – 3:55)
Fantastic. Fantastic. So, Mike, most of the people who are working with are founders of businesses who are at some point maybe not at maturity yet, but there’s somewhere in the mindset of at some point they will need to exit this business and begin planning for that.
Some of them are sole owners. Some it’s a it’s a married couple that’s running the business. They’ve had over 30 years or so.
And others have a business partner. So if you could talk about, let’s say, someone who’s three years out from that exit, maybe three to five years out from selling that business or somehow transitioning that to the next generation from risk management standpoint and how life insurance can can fit in there to help them have a more successful exit. What are some of the things that they really should be thinking about or considering?
Mike (3:56 – 5:55)
Well, I think the secret is, as you’re helping them as well, is crystallizing kind of how they want their life to play out. And this business is kind of like the goose with the golden eggs. Right.
It’s creating the revenue and cash flow and the monetary financial backing to solve that retirement objective. And then it’s what do you want to happen? And how do we make the business play that out?
Right. So a lot of that is aligning your key people to that plan. So whether it’s a transition to some of your family members, to some of the key people, right, the earlier earlier you start that in the more crystallized the goals and objectives are and all parties are aligned, the better that transition happens.
Right. And the whole the whole objective usually is to protect the company as it goes through this scenario. And from a risk management perspective, it’s those vital people that are that make that happen.
What if all those what ifs happen? How do you protect those people? Right.
So a lot of times it’s aligning the key people. It’s protecting the owners. Gosh forbid one of them passes away.
Gosh forbid one of them gets a divorce. Gosh, for one of them gets the disability. Right.
There needs to be all those rules and game plan in place so that there’s a system and a plan to help that business and help those partners and key people kind of maintain and pick up the ball and carry it and keep that business going. Right. It’s the more you kind of tie it, the more the more defined you can get what the mission is, then you can come in and create a really good plan to protect all those people, those families.
And those employees.
Armando (5:57 – 6:48)
Right. Excellent. And I’ve had a number of conversations here in my office with people who who some of the basics that I would I would expect, you know, a key man insurance policy or a buy sell agreement when there’s a partner or when there’s a sole breadwinner in a family.
And and I’m thinking of a specific partnership as I as I speak, but a specific company where there was a breadwinner of the family and the spouse stayed at home with the young child. And that part of the business didn’t have any life insurance at all. And, you know, where would that leave his wife and his young daughter if he suddenly wasn’t around?
That could be catastrophic to the family. The business would be a little bit in a better position because it did have another partner. But the family, it would be devastating to them.
Definitely.
Mike (6:48 – 7:08)
And we come across a lot of businesses where the business is one person. They’re the face, they’re the vision, they’re the driver. And a lot of times kind of they take it for granted.
Right. How they they don’t realize how important they are to that business, but also to the family.
[Speaker 3] (7:08 – 7:08)
Yeah.
Mike (7:08 – 8:00)
So how do you capture that value of that person? Gosh forbid something happens to them to one is protect the family, because a lot of times that business is not the same. It doesn’t have the same value.
It’s not transferable. So you really have to capture the value of that business. Right.
And pass it on to that family. And there’s various ways to do that. And insurance, obviously, is one of those, you know, options that help solve that liquidity problem.
And the other thing we see is a lot of buy sells. Right. When you start your business, right, you’re excited.
You just you just want to get it going. And a lot of times the documents you put in place in the beginning. Right.
Usually aren’t as detailed with all the various scenarios that could happen, as it is 10 years, you know, from inception.
Armando (8:00 – 8:01)
Right.
[Speaker 3] (8:01 – 8:02)
And business change.
Mike (8:02 – 9:21)
Businesses change. They grow partners. All those things change along the way.
But the documents, right, aren’t the first thing people want to spend time, you know, focusing on and adjusting right and paying for it. So a lot of times we see those documents outdated and or we’ll see a good document and life insurance in place for a buy sell. But the company is worth 10 times more than it was at inception.
And it hasn’t been kept up with. So so what we spend a lot of time doing is just helping walk through what a buy sell should look like. All the six different contingencies that should be in it.
Death, disability, divorce, voluntary leave, nonvoluntary leave and retirement. Those are all the contingencies that you should have in that document. Very rarely are all of those covered.
So a lot of times it’s just having those conversations with the ownership group to say which of these is really vital. Now, let’s keep these updated and then let’s look at various right options on the best way to kind of bring crystallize those documents to fit the the family group or the partnership group.
Armando (9:21 – 9:59)
And Mike, sometimes on, you know, on day one, when a company starts, they don’t know what the value of the company is going to be in five or 10 years. And sometimes people really hit paydirt and company just takes off. And might, as you said, have a buy sell agreement in the early years where they think the valuation is pretty low and that it just is doesn’t keep up.
So in, say, five, 10 years, when the value has really increased beyond that initial assessment of what they thought value would be. Is it a matter of getting an appraisal and then getting life insurance that’s going to meet that those appraised needs? How does that work?
Mike (10:00 – 12:22)
So a lot of times there’s so much flexibility and creativity. So if it all businesses are formal, but if you have more of a business that has a life of its own, a valuation is obviously a great way to create a formula that you can use consistently to know what the value of the business is. For a lot of those companies that the key person or the owner is the company.
Those are harder to value. So a lot of times it’s really doing kind of a gut check, looking at numbers, talking with the CPA is if this were a company that had multiple partners in a life of its own and wasn’t so dependent on the owner. What could that value look like?
Right. So a lot of times it’s conversations with the professional group to really get that dialed in. Other times it’s absolutely let’s go get an appraisal.
Let’s create a formula so we know what the value of this business is, is over time as it changes, grows and adjusts. Right. And then a lot of times it you can fund it.
Right. Which means you go get insurance to for the value of that business or some portion of that value so that, you know, if somebody does pass away, that there is definitely a big chunk of money that comes in that can help purchase that company from the deceased partner. A lot of times we see some people fund it.
All of it. Other people don’t fund it all the way, and they just want enough liquidity to make sure that the company and family are going to be OK. And then the rest of that buyout will be over a period of time.
That’s OK. But it’s really just having those conversations and knowing two things is what’s the value of the company that I’m trying to protect? And then what does my family need?
And then it’s kind of just having that conversation to make sure those two work together, because a lot of times there’s kind of a Chinese wall in between there and they don’t they don’t take the value of the company and the personal side and pull together to have that conversation. They’re kind of done in silos. And that’s my really big issue is they’re all one in the same.
It’s a balance sheet and it’s all about the family and the business. It’s just one of those things. So how do they all work together?
Right. To protect the business and to protect the family.
Armando (12:23 – 12:30)
OK. And so you’re navigating both as you’re doing it, it sounds like. I mean, navigating the family side as well as the business side to get to the best place.
Mike (12:31 – 13:32)
Yes. Yeah. And a lot of times that comes with what you had mentioned earlier is key people.
Right. And the same thing happens, right? If a key person passes away for a smaller kind of closely held business is one person can be very vital to the success of that business.
So a key person is a way that the ownership group can buy insurance on that key person to say, great, something happens to you. Our company’s going to be affected and we want to make sure that the company can go on. Now, it’s just how do you quantify that value?
What’s that person really impact the business? And there’s different formulas in different ways, but it all comes down to conversations, right, of who are these key people? How vital are they really to the success of the business?
And then what do we do about that? Right. How do you protect the risk management of that key person?
Right. Gosh forbid they passed away or became disabled. What’s it going to mean to the business?
Armando (13:33 – 14:02)
Let’s go back to the buy sell for a minute, Mike. The and just if you could just walk through some of the mechanics of what that really is, there’s an agreement, a written out agreement, and then there’s life insurance policies on the lives of the the partners of the business. Who owns the insurance?
Who pays for the insurance? How you talked about the value, the perceived value of the company. But if you could talk about some of the mechanics of that, that’d be helpful, I think.
Mike (14:02 – 17:12)
So the agreement. Right. Can either be in the operating agreement, the membership agreement, or it can be a separate document.
And it’s just stating what the rules are. And that might be Armando, you and I are partners that our business is worth, let’s just say, $2 million to make it easy. And we are 50-50 partners that if something happens to me, I want you to buy my shares out or membership interest out.
So my wife gets a million dollars and she’s not messing up your world, trying to come in and be an owner. And I know she’s taken care of. So it’s creating that value one and then creating a written agreement that basically, I’m sorry, here, I got a thing pop up on my screen, that determines the rules.
The insurance is not part of this. This is just a way to create the liquidity to fund it. Now there’s two different types of buy-sells.
There’s a cross-purchase buy-sell. And in that, it’s between you and I. I own a policy on you.
You own a policy on me. And the purpose of that is if I pass away, you own a policy on my life. You receive the death benefit of a million dollars.
You come to my wife and purchase my shares. So you purchase those for a million dollars. So you’ve got a cost basis associated with that purchase.
My wife gets a million dollars. Great. That’s called a cross-purchase.
An entity or a redemption buy-sell, our business would own the policies on you and I. And then if I pass away, our business gets the million dollars. And then it just redeems my shares from my wife.
And that happens. You technically now own a hundred percent of the business, but you didn’t purchase them. So your cost basis stays the same.
It doesn’t increase by a million dollars. So that’s part of the conversation is, do you think you’re ever going to sell this business? How important is that step up in value?
How fast is the business growing? Because it would have a bearing on which type of buy-sell structure you would implement. And in addition to that, as you’re probably thinking, if it’s a cross-purchase and we have five partners, that means we have to have policies.
You have to have insurance on four of the partners. It gets kind of crazy in all these policies floating around versus a redemption is very easy. The company can own a policy on each of us.
So the number of partners, the cost basis, all those kinds of things kind of come into the conversation as to which type of structure is best for kind of the situation.
Armando (17:13 – 17:42)
Okay. And that’s based on, so just getting back to what you said earlier about the value today versus the value in five or 10 years, there was a value of the company today, which industries have their own formulas. You can get an appraisal if need be, but there’s some way to assign a value to the business today, which will be different from what it is in five or 10 years.
Are you allowing for growth? Are you allowing for increased value going forward in those policies today in the buy-sell agreement today?
Mike (17:42 – 19:26)
Sometimes. Yes. It, um, it, yes, that conversation is an absolute must and in the partnership group we’ll say, yes, we’re growing fast.
That’s a risk. I want to make sure we protect. Other mature businesses are more kind of steady, right?
They might be more apt to kind of protect the value today and then any excess growth that would just be a payout over time. Right? So it kind of depends.
Um, one of the things that people don’t realize a lot of times is yes, a lot of times there’s formulas in the buy-sell or it’ll say something like each party will get an appraisal and they’ll take the average of the two or right. There’ll be three appraisals and they’ll take the average. So you can use appraisal.
You can use a stated value. So you and I might agree to sit down and say for death contingency instead of our business being worth two, it’s worth four because you and I know that there’s growth potential that the blood, sweat and tears we put in for the last four years. We want to make sure we capture that for our family, for all the hard work.
And as long as we agree to that, we can state a value for that death contingency and by insurance accordingly. So there’s a lot of options and flexibility and that’s where just the collaboration, the conversations are so important so that the end result is that business ownership group goes great. I feel good.
The risks that I have out there, I’ve protected myself and my family and my partners. Great. And we all know the rules.
Armando (19:27 – 20:05)
Okay. Thank you. That sounds very helpful.
So we talked, we talked about a buy-sell for the ongoing business that has partners. We talked about key man insurance for key people to, I guess key person is maybe more appropriate, but the key people in the organization that are vital critical to the ongoing success of this business. They have a, they have more value than maybe some of the other folks in terms of the ongoing of this business.
What about, you hear sometimes about corporate owned life insurance where the company owns it. What, what kind of benefit does the owner of the business get from, from corporate owned life policies?
Mike (20:06 – 22:21)
So I think one of the things that goes along with this risk management piece, one of the risks is losing your key people. So one of the things that we have a lot of conversations around, as we’re talking about this buy-sell and protecting the partners is kind of executive compensation, right? Different ways to attract, retain, and keep those key employees tied to you.
And there’s a bunch of different ways to do that with, obviously you can give ownership, you can do all kinds of different non-qualified executive compensation type of programs. One of the common ways to do that is insurance, like you said, is a way to do that, that you can basically have the company own a life insurance policy on a key person. And there’s a certain amount of death benefit they want for the key person insurance.
There might be a certain amount of death benefit that they want to give that key employee the access to their family. And then what the company can choose, or you and I could choose for one of our key people is to say, great, we want to keep you here, Tom. And we want to say, great, if you’re here with us for five or 10 years, we’re going to put aside 20 grand a year for you.
And if you’re here five or 10 years, whatever we determined is that timeframe, we’ll give you that. So you can combine the key person insurance need for the company with a monetary reward system that doesn’t have anything to do with your 401ks and profit sharing plan. All those are called a RISA or qualified monies.
This, you can discriminate, you can pick the key people and do something in addition, very specific to your kind of alignment of them to your goals and objectives of the company. And insurance is one of those things we use a lot because it accomplishes multiple things at the same time.
Armando (22:23 – 23:02)
So with that corporate owned policy, if the goal is to retain somebody say for at least five years, and there’s a written agreement that says, Hey, we want to keep you on board at least five years. And if you stick with this at least five years, the, the, and this is more of a question versus a statement, Mike. The question is there would be a life insurance policy owned by the company and that would be building cash value that the company is adding to every year.
And that at the end of that five years, then the company is the company then reaching into that life policy, pulling the cash out and giving that to the employee. Or is that, how does that typically work?
Mike (23:02 – 24:51)
So that the company has the freedom to use that cash value or other cash that it has on hand or cashflow to pay out that commitment. They’re not directly linked. All the life insurance policy is as a way to accomplish what you said, which is get the death benefit for the parties that need it, but create a holding tank to accumulate cash for the future.
And when, when we say these traditional, these life insurance policies designed for this, these are institutional uniquely designed policies. You’re not using the traditional personal type of policy. So there’s riders where the company can have what they paid in, in cash value.
So there’s very unique things you can do. So the company balance sheet is not affected and looks good or even optimized. Right.
So there’s a lot of ways to combine very unique policies. But yes, it’s just a holding tank for this financial potential commitment that they can choose to use or use other assets and keep the policy. A lot of times there’ll be a, at the end of that five or 10 years, that person is still there.
It’ll be kind of like, let’s just extend this. They might say, I don’t want the money yet. Keep it and keep adding to it and let this continue to grow.
And then you’ll create a new timeframe. So as long as the employees still with you, right. You can do that.
So very, they’re very, very flexible and creative and designed versus very commoditized.
Armando (24:51 – 25:22)
Okay. And often as you know, business owners when it comes time to selling, sometimes they’re very, very, they go into stealth mode. They don’t really want people to know that they’re thinking about selling the business.
Even when they might engage the investment banker to help them sell the company, they still want to keep things quiet and they don’t want to scare off the employees. So it sounds like this could be a tool to help the business owner or owners keep people on board through the sale or maybe at least up to the sale if nothing else.
Mike (25:23 – 28:07)
Yeah. A lot of the purchasing companies want to make sure that the revenue and the key people stay in that’s creating the success of the company and why they want to buy it. Right.
So, so it’s kind of an advantage to that purchasing company to know that there’s loyalty and programs in place that incentivize those key people to drive the growth of the business, right. Selfishly, right. So a lot of times that’s an advantage to the purchasing company.
And a lot of times there’s clauses in those agreements that the purchasing company can keep that plan or they can close it down and all that money invests and goes right to the key people. But yeah, that is a, a great alignment tool. But if I could say in our experience with business owners, I think involving those really key people, not going at it of I’m thinking of selling, but approach it in there.
As you know, I’m getting older, right? There needs to be some kind of plan within my business and I’m exploring various options and I would like to get some of your input and thoughts and involve those key people in the conversations, not with the owners. A lot of times the employees will tell the owners what they want to hear, but from a third party, come in and interview those key people.
So you know where their heads at and then they’re going to be much more confident knowing that there’s a plan and a high probability of success versus if they’re uncertain and don’t know and know that you’re getting older in age and there’s going to be some kind of transition, right? That uncertainty causes far more chaos and potential leaving than involving them the right way to embrace, let their voices be heard because a lot of times that creates the confidence and, and value creation and those people are more apt to step up and be part of that transition versus being afraid of that transition. So I would encourage doing it the right way and involving those key people and you can do it in the right verbiage so that you’re not, you’re not telling them what that I’m going to sell to a private equity group, right?
It’s not the objective. The objective is just to say, I got to come up with some opportunities and plans with to keep this business going and we’d love to just kind of hear thoughts and get some, get your voice involved and that usually is always beneficial.
Armando (28:07 – 28:40)
Okay. And you mentioned about sometimes employers will give ownership to key people to keep them on board. Sometimes it sounds like they can use a corporate owned life policy to, for the same purpose, or maybe even I’ve seen a defined benefit plans or other risks or qualified plans that can be put in place as well that, that kind of puts a carrot on the end of the stick so that there’s something there beyond this sale of the business for that key employee and that person’s family.
Mike (28:41 – 29:26)
Yes. There’s profits interest where you can not give them stock, but the value of the stock that appreciates your rewarding them with that value appreciation. So the, the value is tied to the stock, but the reward is not stock.
It’s just an economic value end of the day or agreements that if we have a transaction, there’s a third party sale, they get a certain piece of it, right? So they’re more apt to drive and align with you towards that success. There’s a lot of different creative ways to reward those people and align them to the goals and objectives.
Armando (29:28 – 30:29)
Okay. So Mike, often when people sell, it’s, it’s the, it’s the biggest payday they will ever get when they sell their company. And for many business owners, their largest asset by far is the business that they’ve created years and years ago.
And as they’re thinking about that exit, they’re going to have typically a big, a big tax hit. And that’ll be the biggest tax that they’ve ever had. And then once the sale is done, then, and they’re no longer part of that company, then that’s a whole new phase of their life.
And as you’ve, as you’ve seen some companies gone through that and, and, and had conversations going through that, where, how can you help in that, in, in going through that transition? We’ve talked about some, some ways already to secure value of the business today, but as they begin to go through that transition and plan for that transition and then beyond that transition, how can you be helpful to that business owner as they’re thinking about those next steps?
Mike (30:30 – 32:33)
I think that’s really important. Why what you mentioned from the very beginning is that conversation happening three to five years before it actually happens. So you have the ability mentally, right?
To know what that potential outcome is going to look like. And you can prepare yourself for new hobbies, new things, right? Because a lot of times entrepreneurs, the business is their life and is their bait.
And it’s really hard all of a sudden to just flip the switch to that, not being the situation, right? So the more time you have to create potential hobbies, different interests, different family dynamic, travel, second home, things that right, can divert in a good way. Right.
Where you’re going to spend your time. And I think that takes quite a while. That does not happen quickly.
So right. The longer you can prepare for that, the better because you can teach yourself and plan, right? Almost like exercising, right?
Get in shape for this next phase. Two is we also work with quite a few counselors that come in and just help with that new identity and that new you. What’s that going to look like?
Where’s your time going to be spent? Right. And, and that has great rewards as well.
As just helping the outside party, just helping you work through that. And a lot of times it’s the family too, right? There’s the spouse that all of a sudden has complete change in their world too.
Right. Right. Where all of a sudden husband’s home or wife’s home now and you’re together, you know, 24 seven and like, Whoa, this wasn’t what it was like for 30 years.
So there’s transition in all parties. Right. So I think the earlier you do it, the better.
And I’m also bringing in kind of those experts to just help with that. We see good success when that happens.
Armando (32:33 – 33:06)
Right. So then I guess more specifically, Mike, and I agree a hundred percent, that’s all extremely important for that. The family success beyond the sale of the business in you know, sometimes when people have big tax hit, they want to minimize that going forward as much as they can.
And they might want to use some different life insurance tools that can help them do that. So, you know, from your perspective on that, what kind of tools, how could you use insurance going forward to help them accomplish that?
Mike (33:10 – 34:51)
I don’t know if insurance is always the solution to avoid that tax upon sale, but there are a lot of ways to do some gifting and proactive things prior to the transaction. And that’s the whole key is really talking through those way prior to the transaction. So you have different examples of, you know, there’s, you know, class and various different structures, and some of them are more aggressive than others, but there is some ways to potentially set the stage for when that transaction does happen.
There’s some minimization of the tax from an income perspective, but also from the estate tax potential issue, right? Gifting some shares out of the estate, various things like that, or just asset protection. I think that’s something that is not talked about a lot, but once you have that big payday and you get money, is there ways that when you get that money, it’s in creditor protected or asset protected environments, right?
So if you get 15, 20, $30 million, it’s far better if it’s in a asset protected environment versus not. So there should be a lot of conversations around those potential strategies, whether it’s using trusts or this is where insurance becomes a viable option, because depending on the state you’re in, there’s creditor protection on the cash value. So there are ways to structure your assets accordingly to help with that.
Armando (34:52 – 35:37)
Right. And you mentioned creditor protection and asset protection. Let me just expand on that just it’s a little more, maybe a little more clear.
Those terms get thrown around a lot and to you and I those mean very specific things, but to someone who doesn’t really know what those means, what it basically means is if someone sues you, then the asset itself, that value that you’ve put somewhere is a bit is somehow shielded from that lawsuit. And that could be through a trust, as you, as you mentioned with life insurance in some states there’s creditor protection. So again, if that lawsuit comes about and the value there’s cash value in a life insurance policy, then it is protected from that lawsuit and really can’t be taken that that’s what you’re talking about.
Correct?
Mike (35:38 – 35:38)
Correct.
Armando (35:38 – 35:47)
Yep. And that’s a state by state credit protection with life insurance, a state by state rule treatment, et cetera.
Mike (35:47 – 36:02)
Yeah, correct. Okay. So Arizona is fantastic on that front, but California is not.
So California, if you live in California, you get very, very, very little asset protection with life insurance. As an example.
Armando (36:02 – 37:18)
Okay. I’ve met people along the way. Mike is, I’m sure you have two that have these life insurance policies.
They’re putting big chunks of money into them in Alaska. And what, you know, what is the purpose of this thinking of exiting your business? Come to this Gastiel founders forum, a biannual live event for you, the founder, considering exiting your business in the next 36 months, more information.
It’s Gastiel founders forum.com. And often the answer is I don’t remember, or I don’t know. I’ve just been doing it so long that I just keep doing it.
And they, they, on day one, there was a, there was a plan, a purpose presumably, but they’re not quite clear. So for that, for that person who has that policy with a lot of cash value in it, I think it goes back to what you said that, you know, what is the, what is the plan today going forward? And those plans change over time.
But the way that cash can accumulate inside life insurance policy, what other than creditor protection and ask protection, why would somebody want that cash to accumulate in that policy? What kinds of purposes, what kinds of uses could it be there for?
Mike (37:19 – 40:11)
So when you’re dealing with most business owners, right, they’re usually the higher income earners and usually in the higher tax brackets. So one of the benefits of life insurance is it has the same tax treatment as a Roth IRA, for example. So the cash value that’s in that contract grows tax deferred.
So you don’t pay taxes on it as it grows. And then life insurance, you have the ability by using loans to get that gain out tax-free. So it kind of works like a Roth IRA.
One of the great things about insurance, unlike a Roth is you can put money in, take it out, put it back, right? So it’s a more flexible thing to use to have money go in and out, right? So the money that goes in there that you might need for your business or something, you have the ability to pull it out and potentially put it back versus the Roth that you put it in.
Once it’s out, it’s out. So wealthier, higher income individuals, a lot of times are using insurance to create that tax bucket. And when you’re doing that or creating that tax free income, these policies should be very, very specifically designed.
And what I mean by that is if you’re trying to optimize the cash value growth and the tax free income, you need to minimize expenses and costs inside those policies. So any normal policy that is out there, you really want to take a look at because you want to create institutionally priced insurance, meaning how can you reduce all these commissions? How can you reduce the expenses that are internally within them?
And there are certain types of policies that are built to do this. And there are certain policies that aren’t, right? So there’s permanent policies that have cash value, but they’re not built to optimize tax-free growth and tax-free distribution.
They’re built just to let cash value grow. Well, that is a costly endeavor compared to the other options. So always, if you do have significant cash value in your contract or the purpose is to build that up, really spend time to get a second opinion on what is that, what is, how is my chassis working?
How is this insurance policy working? Is there more efficient ways to reduce all those expenses slash costs so I can get more of my money?
Armando (40:13 – 40:30)
And Mike, if somebody has money in a policy today, and maybe, as you said, the chassis, maybe, maybe it’s not on the right chassis today. Can they move that from that policy to one that has the right chassis without taking that tax hit?
Mike (40:30 – 41:29)
Yes, there’s, it’s called a 1035 exchange. So you have the ability to roll those cash values and cost basis into a new contract. And I would, excuse me, I would say probably 85% of the permanent policies that we see can be greatly improved.
15% of the time when we do an analysis, we see policies that were well-designed and good. But that’s a rare percentage, but it’s a very easy ability to switch into a new product. You just have to analyze, right.
And do an analysis around it. And make sure that you’re not, because there’s sometimes surrender charges in these old policies you need to look at, right. It’s not just an easy assumption.
You really have to make sure you’re looking at all the costs benefits and doing an analysis.
Armando (41:30 – 42:15)
Yeah, that makes sense. And people may be familiar with a 1031 exchange. You said a 1035, that’s for insurance.
Obviously a 1031 exchange is kind of the same idea, but when real, with real estate or some other, other assets, I mentioned that because people I’d say, especially here in the Southwestern Arizona, a lot of people have rental property, rental real estate, and they may be more familiar with the 1031 exchange where they can sell that piece of real estate, roll it into something that is comparable or what’s considered like kind and pay zero tax on that transition, on that transfer.
In life insurance, the same idea, the same concept exists, but that’s a 1035 exchange. Correct?
Mike (42:15 – 42:27)
Correct. Yeah. Yeah.
There’s just, there isn’t the timing restrictions that you have with the 1031. So it’s a little bit more flexible and easier in that sense, but yes, exact same tax treatment.
Armando (42:27 – 42:49)
Yeah. And, and I like the the 1035 exchange because in that, if there say is a chunk of money in a life policy and on, on when that policy was started, maybe it had a purpose, but that purpose no longer exists. So that cash could be then be re reassigned to maybe long-term care, right?
Mike (42:49 – 42:50)
Absolutely.
Armando (42:50 – 43:02)
So maybe they don’t need that death benefit anymore. Now maybe they need long-term care because now they’re older and they realize that they will, they will likely need that as they continue through their life.
Mike (43:03 – 43:44)
Yes. And then, and the new life insurance policies have been very creative and proactive around adding that long-term care. It’s called a rider, but fantastic benefits, much more economically priced than a traditional standalone long-term care policy.
So that is absolutely a big conversation and stuff. We do a lot is what’s the long-term care concern and is there ways to kind of use your life insurance and that leverage to solve that. And they have great riders and options now that are fantastic.
Armando (43:46 – 45:12)
Good, good. So I do want to touch on also, sometimes we’ll talk with people who have a lot of money in IRA, just a ton of money in their IRA or their 401k. It’s all called, you know, the general category is qualified money.
And of course, every dollar they pull out is going to be taxed. And within, you know, within your space, within the life insurance space there are sometimes strategies that are used that, that can help not pull the money out tax-free from an IRA or 401k. You can’t do that, but maybe to offset some of that and get some of the more money from that person to the next generation.
And I’m thinking about when that, when that business owner sells their company, they’re often thinking about that chunk of money and how it’s going to be used for the greater good of, of not just that couple, that spouse and them and their spouse, but their kids and grandkids and future generations. And so the more of that they can keep in their pocket versus paying to for taxes than the more they have more of an ability, presumably to help accomplish some of those goals. But when the money’s inside an IRA or other qualified, then it, it, it can, they can feel a little bit handcuffed.
How might you be able to help unhandcuff some of that?
Mike (45:13 – 47:49)
So, excuse me, our conversations are usually with those individuals that they don’t need the money in this qualified environment, right? To live on. They have all the other assets there to do that.
So this qualified bucket that you’re referring to is the worst asset from a tax perspective. Cause every dime you pull out, you pay ordinary income tax rates and if you leave it to your children, they pay income taxes. It doesn’t get a step up in basis.
So to solve that there’s, there’s a couple of different ways that a lot of times you can just pull out small amounts and then go buy a life insurance policy in an islet and your replicable life insurance policy to leverage the death benefit, right? For estate planning purposes or legacy. That’s one of the options.
With the secure act, what happened is they, the secure act opened the door for the ability with profit sharing plans. And a lot of times you can convert these existing qualified plans to a profit sharing plan, but it opened the door to do some great things with life insurance inside the profit sharing plan in ways you can get it out in really little amount of money and lever these taxable dollars to tax free dollars. So there’s a lot of great options now in doing that.
What you’re doing is you’re using less of your exemption or gifting amount that a lot of times you’re, you’re using when you implement a state tax planning with insurance is you’re gifting money to an irrevocable trust. That’s buying life insurance in it. And you’re using either some of your exemption, right?
Or annual exclusions. If you’re using your exemption, it’s dollar for dollar on those premiums. When you use this profit sharing plan, there’s a lot of leverage that gets created to get that money from there into this trust to buy life insurance.
And it’s takes, you know, a half hour, 45 minute conversation just in the, in, in those steps, but it really opens the door for wealthier individuals that have a state tax problems to use this asset that they really don’t. It’s the most efficient asset on the balance sheet to solve that problem very efficiently.
Armando (47:51 – 48:42)
Okay. So Mike, we haven’t, we have not talked yet about, about philanthropy and charitable giving when people have that big, that big payday when they sell their company and they’re, they realize that they’ve got more than they can really consume in their lifetime. And they want to often help their adult kids, the grandkids, with college education, et cetera.
But they’re also often very philanthropic and they want to give, they want to help the greater community for the greater good. How, from your perspective, you know, as you think about risk mitigation, you think about, you know, life insurance policies and how can those help people when they’re going to say sell and they want to give to charity, whatever charity they choose, how can the tools in your tool chest help them?
Mike (48:43 – 50:41)
So a couple of things is one is a lot of times for when you’re looking at your balance sheet of your assets and you do have a charitable intention upon your passing, for example, that a lot of times the life insurance that an existing life insurance policy might not be needed to protect the family, but that could be a asset to use, to gift to a charity for long-term charitable legacy. Right? So how do you optimize that and do that in the best scenario is an option.
So just analyzing that, but as well is a lot of times that, you know, the traditional method for a lot of that is just to give assets upon your passing. So it lowers your taxable estate by doing that. A lot of times what we use life insurance for is you can go pay off your life insurance and you can pay a much smaller premium for a life insurance policy and an irrevocable trust that goes to your heirs and give away a lot of your assets directly to the charity to reduce your estate tax.
And then you’re just replacing that value with a tax-free death benefit in this trust over here. So it’s just the efficiency of giving things like your 401ks and assets to the charity upon your passing to reduce the estate tax and then just replacing that asset with life insurance at a different trust that you can have legacy planning. You can have all kinds of different enhanced creditor protection strategy with, right?
By using that strategy.
Armando (50:43 – 53:28)
Yeah. I’m on the board of a local nonprofit where it’s, fairly common that people will do exactly that. They will name as a beneficiary of their life insurance policy.
They will name this charity so that when their time comes, the charity does in fact get a chunk of money that can be used for legacy purposes to help them accomplish whatever they want to accomplish with that, with that chunk of money, the charity. Sometimes they can define, they want it to go towards scholarship, sometimes towards, you know, healthcare towards really whatever they want. And it’s part of their, their legacy as they, you know, transition themselves into that next, that next phase, whatever that, whatever that may be.
So I’m thinking again of that, of that business owner who is, who is again, thinking of that sale coming up. We talked about if I can just kind of recap a little bit here, we talked about making that business more solid today. And we talked about that with key man light or key person, life insurance policies.
We talked about buy sell agreements with partners to take care of the company today, keep it solid and take care of the family as well. Should a partner deceased take care of the deceased partner’s family. We talked about corporate owned life insurance policies again, to keep people on board, maybe through the sale of that business or transition to the next generation of that business.
Again, keeping that business solid. We also talked about some of the, you mentioned the, that, that, that a, a policy can be kind of a Roth IRA concept where the earnings in that or the the increase in value of that cash value is not taxed and it can be accessed. Unlike a Roth IRA can be accessed.
You can pull the money out, put the money back in. And that can be a, sounds like a versatile tool for a lot of, a lot of purposes. And then one thing about, I don’t know that we touched on enough, when that sale does happen and now they’ve got a chunk of money, you talked about asset protection and creditor protection and state by state, of course, for creditor protection in life insurance policies.
But we talked about how that can help with their legacy purposes, but also protecting the value that they now have once the company has gone, once they’ve sold that business off and now what they have is a chunk of cash. What do they do with it to protect it for the health of the family going forward? That sometimes life insurance might be the appropriate vehicle for some of that as well.
Mike (53:29 – 55:30)
Yeah. And I think so we talked about, you know, using these permanent policies to hold money for the key people. The same thing goes for the ownership group.
So a lot of times you and I could buy insurance for our buy sell, but purposely set up these permanent policies that the company owns, right? That building or building cash value. So we have access to use them for the business, but also if we do sell our business, right, we can take these policies ourselves as part of that payout.
And now we have a big chunk of money in a creditor protected bucket, but also a real tax efficient bucket. So it’s also a way for owners to solve their buy sell arrangements, but also use the business cash flows to feed a mechanism for them to use, right? For their retirement planning and create this Roth like bucket for that.
So we do a lot of that type of strategy. And that’s why I say these conversations and the creativity is every business owner and their situation is so different. It, you have so many options, then it’s basically just crystallizing really what, what are those outcomes and those goals and objectives.
And then great, here’s the various ideas or strategies or things that you can use to help solve those and do the risk management piece, but also potentially help with the proactive future tax planning, retirement planning and cashflow planning. So it’s combining all of that. And I think that’s a uniqueness in our world of being able to have all of those conversations versus, you know, in silos.
Armando (55:33 – 55:42)
Yeah. And so it sounds like a lot of flexibility there for, for what can be done with that when it comes time to say, exit that company.
Mike (55:43 – 55:44)
Yes, exactly.
Armando (55:45 – 56:23)
Okay. Okay. So Mike, what have we not talked about in this conversation is thinking about that business owner and his or her family, and they’ve got this company, they’re starting on day one, they grow it for say 30 years, maybe they bring on a partner, maybe they make employees give them some ownership along the way.
And then it comes time for them to think about exiting say three to five years out, they begin to plan for exit work towards exit. And then they actually exit. What have we not touched on yet in that whole cycle of that business and really in that family that you talk about with your business owners about as you’re having those conversations?
Mike (56:24 – 58:27)
One is obviously the earlier and the more preparation, the better. Two is a lot of times the things you can implement today, you can, you can take to the future and do things good today that are also good for the future, right? Whether it’s post, you know, the sale and the legacy of the family or asset protection of the family or cash flows of the family.
A lot of times you can implement things now that will really set the stage for this to be fantastic. It takes a little forethought, takes a little bit of planning, right? But that I think is a lot of times, I think that a lot of business owners are in such a, they’re working so much and have so many foes and juggling, you know, keeping things in the air and all that, that a lot of times they just put band-aids in places to just solve things in a short run.
And if I could say, if you could pull back just a little bit to have deeper conversations, I think the implementation of these ideas and thoughts now can really impact the future. The last item I would say is there’s so many different ways to exit now. And I think sometimes we get told by a professional a certain type of exit and it just sticks as opposed to maybe kind of slowing down and saying, let’s look at all these potential options and then which one is best for our situation.
Cause a lot of times when a lot of business owners come in, they say, I want to do this. And we’re like, okay, great. But as you get talking and you work through that, that really isn’t the best solution, but that’s what they have in their mind.
So I think just spending a little time educating what are all those potential options and how there’s goods and bads with all of them, but which one ultimately creates the greatest outcome for the family or the business ownership group.
Armando (58:27 – 59:18)
Right. And depending on what their goals are is, is going to help depend on which of those really is the best choice for them along the way. But, but I agree a hundred percent.
Often people will hear something and they’ll latch onto it. Yeah, I’m going to do that. And that might not be the best choice for them, but they just don’t know.
So having those conversations to help understand what are they really trying to get to? Do they really want to take care of the employees? Do they want to sell for the highest price?
Do they want to transition to their own next generation? What are they really trying to get to? And then talk about, well, how can you get there and what’s going to be the best way to get there.
But that broader conversation is so critical versus, as you said, you know, band-aids to fix things along the way. Very, very important. Anything else, Mike, that we haven’t touched on yet in this conversation that comes to mind for you?
Mike (59:19 – 59:23)
I don’t think so. I think we covered a lot fairly quickly.
Armando (59:24 – 1:00:19)
Yep. I think we did as well. And that’s what I wanted to have this conversation with you that there’s, there is so much that is within your world for that business owner that could be helpful to them, helping them protect the family, helping them protect the value of that business, helping them retain key people along the way so that that business remains healthy, helping them go through that exit.
And then beyond the exit of the business, helping again to protect the family and help create that legacy and help them with their charitable philanthropic goals as well. There’s so many places along that, that, that life cycle of the business and really the life cycle of that person and that family where your expertise can be helpful and help them accomplish the goals that they really do want to accomplish. Good.
So Mike really enjoyed the conversation. I’m curious if somebody had questions and wanted to reach out to you, what is the best way for them to reach you?
Mike (1:00:21 – 1:00:25)
Mike at wealthpoint.net.
[Speaker 3] (1:00:25 – 1:00:26)
Okay.
Mike (1:00:26 – 1:00:37)
Or I’m a phone person, so feel free to just pick up the phone and call me on my cell 480-695-7747.
Armando (1:00:39 – 1:00:52)
Okay. So let me just repeat that. And then we’ll get that printed down here below.
So I said, Mike at wealthpoint.net, correct? Correct. Or the other way is your cell 480-695-7747?
Mike (1:00:52 – 1:00:53)
Correct.
Armando (1:00:53 – 1:01:57)
Great. Perfect. Mike, thank you so much for the conversation.
Hoping that the business owner who, who has some questions or thoughts, or maybe as you said, a second opinion on what they already have in place, hoping that they will hear this, get some golden nuggets from the conversation that can be helpful to them. And if they have questions for us, they can reach out to you or reach out to me as well. And we’ll have a conversation with them so we can help them get further along with their business and their family.
Thank you, Mike. Really appreciate the conversation. Thank you.
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