Shareholder Protection Shareholder Protection is effectively an agreement between shareholders which is backed up by a series of Life Assurance policies and trusts. In this agreement, the conditions are set out regarding what should happen to the shares in the event of death. For example, will they go the deceased’s family, will they be evenly split with the remaining shareholders or will they be sold on the Open Market. The Life Assurance Policies would provide the finance in this instance. As we saw in ‘Example 2’, a Cross Option can be embedded into this agreement, which means that the surviving shareholders have an option to also buy the shares from the deceased party’s family. In terms of ensuring that your business will continue to thrive in the event of your death, this is, in our opinion, the best Protection product to look into. Shareholder Protection Insurance guarantees that in the event of the death of a shareholder, the surviving owners will be given sufficient funds in order to buy the deceased’s stake in the business. By doing this, the surviving shareholders will remain in control of the company and the beneficiaries of the deceased’s estate (i.e. your family) will receive any interest accumulated from the shares, or indeed the profit of the sale of them. Shareholder Protection Insurance will enable your business to continue to be operational and your family to receive a financial gain.
Colin and Ravi are equal directors and shareholders of a catering company, which they set up 4 years ago. Both of them are involved in the day to day operations of the business, even though they employ over 40 members of staff. The two men both have wives and children, but none of the family members have the skills to run a business and the children have no urge to follow in their father’s footsteps. Colin and Ravi decide to set up two Keyman Insurance policies in order to protect each other’s lives if the worst were to happen. This would mean that in the event of sickness, incapacity or death, the two families would be looked after and the business could still continue to operate. In this instance, Shareholder Protection policies are set up under a business trust with a cross option agreement. This means that if one of them should die, the payment received goes straight into the company and the shares that the deceased owned go to the respective family. Of course, the family have no interest in the business so do not want the shares, they want the money. Conversely, the surviving business owner wants the shares, not the cash. This is where the Cross-Option Agreement comes in to play.
This agreement means that if one party is dissatisfied with the outcome and wishes to contest it, the other party must oblige. In this case, both parties are eager to do this, so that the family get the cash and the remaining business owner receives the shares. The family are financially comfortable and the surviving business owner has full control of the company. Everyone is happy. There are two perspectives to consider when looking at the benefits of Shareholder Protection Insurance. Firstly, if you have a business partner, or rather fellow shareholder, you will benefit if this type of insurance is in place. Imagine that your co-owner falls ill or even dies. By having Shareholder Protection Insurance in place, you will be given a lump sum which you can use to buy their shares and keep control of the business. By having complete ownership of the company you make the decisions. You can decide what is best for the company, for example you may want to replace the deceased or incapacitated Shareholder and bring someone new onboard. The terms of the Shareholder Protection Insurance state that the deceased Shareholder’s family will not be involved in the running of your company (they will sell the shares to you, so they benefit financially and you gain control of the business). This is reassuring, as you can be safe in the knowledge that someone who is not familiar with your business will not be in control. You should also take comfort in the fact that you have been able to purchase the shares in company without having to borrow money. This means that you have put the company in a financially strong position, i.e. no debts to repay or loans from the bank that are hanging over your head. In the second perspective, imagine that you are the Shareholder who is ill, or has sadly passed away.
Shareholder Protection Insurance will make sure that your family will receive a fair value for your interest in the business. This type of insurance will give you peace of mind, as the sale of your shares will realise the true value of your stake in the company. By having Shareholder Protection in place, you are also preventing any added pressure on your family in the event of your death. They will not have to try to find a buyer for your shares in the business, as they will automatically be obliged to sell them to the fellow shareholders. All of the hard work that you have put into your business will be paid back to your family. There are also benefits that can be attributed directly to you from Shareholder Protection Insurance. Say for example you fall ill. The last thing you need is the added worry of financial matters, which could hinder your recovery. This type of Protection will eradicate this, meaning that you can get well without any stress. You can also be safe in the knowledge that you are preventing the company ending up in financial jeopardy, caused by them having to borrow funds to buy your shares. Finally, Shareholder Protection will enable to you to retire with no money worries-as long as you are a shareholder, your family will always benefit. As you can see, Shareholder Protection does not only benefit your family, but it also benefits your company- whether you pass away or if a fellow Shareholder dies or is taken ill. This type of Protection is something that we would recommend to all business owners.
Partnership Protection comes in three main forms; ‘Buy to Sell’, ‘Cross Option’ and ‘Automatic Accrual’. In essence, this type of Keyman Insurance is the same as Shareholder Protection, however this deals with the actual ownership of the business, rather than just shares.
As the owner of a Company, Keyman Protection should be something that is a strong consideration for you. At the end of the day, the implementation of such a scheme could save you hundreds, thousands and in some cases millions of pounds. Keyman Protection is a safety net that could also ensure that your business is protected for the future. This type of insurance can be incredibly complicated, so we highly recommend seeking professional advice from an independent financial planner. At Efficient Portfolio, we have years of experience dealing with corporate clients, so we are here to help you with your Keyman Insurance.
We wanted to look at a type of Trust which will safe-guard your loved ones inheritance from divorce.
As a married couple, if your total estate including your pensions exceeds the nil-rate band (currently set at £650,000 for a couple), your next generation are likely to be faced with a 40% Inheritance Tax bill on the excess. It is also worth considering that the UK has the highest divorce rate in the EU. With this in mind, it seems a shame to work hard to save into your pension, only to have some or all of it taken away from your family by the state or from a divorce in the family. A special type of trust for your pension can help to safeguard this valuable asset against these issues.
Trusts are a very cost effective way to protect your family’s assets and to reduce your Inheritance Tax (IHT) bill. However, many people are oblivious to the issues that can arise without them. Trusts provide probably the best protection when it comes to making sure that everything you have worked hard for stays in the family. The Spousal Bypass Trust is a specific way of using a traditional trust arrangement to protect your pension fund; often the second largest asset someone has. So how does it work? The best way to answer this is to look at an example of what usually happens without one.
Mr and Mrs Smith have a joint estate worth £1 million, plus Mr Smith has a pension policy worth £500,000 and has nominated Mrs Smith as the beneficiary of any death benefits.
On Mr Smith’s death before retirement, Mrs Smith inherits the whole estate, including the pension as a tax free lump sum. No Inheritance tax here, so all seems fine at this stage.
The problem arises when Mrs Smith dies. At that point, the pension value is now added to the estate, so her total estate is now £1.5m. As a result, Mrs Smith’s Inheritance Tax liability after the joint nil rate band (£650,000) would be £340,000.
That is a significant reduction to the family’s wealth, but this could have been worse. What if Mrs Smith had remarried Juan, and then divorced him later in life? That might have cost the family £750,000. Or worse still, what if Mrs Smith had remarried Juan and then died; that could cost the family the full £1.5m if Juan gets his hands on it! Finally, if Mrs Smith went into long term care at a typical cost of £48,000 per annum, the estate will rapidly be eroded.
So how would a Spousal Bypass Trust help?
Nothing changes during Mr Smith’s lifetime other than the need to assign the death benefits of the pension to the Spousal Bypass Trust that has been created. On Mr Smith’s death, the death benefits pass to the trust. Family or friends, including Mrs Smith, are trustees to keep the running costs to a minimum, and they make an interest free loan of the full £500,000 to Mrs Smith.
Mrs Smith can use the funds as she needs during her lifetime, but on her death the funds can return to the trust to be reallocated to the children. This would save Inheritance Tax on the £500,000 that had come from the pension, an immediate tax saving of £200,000.
Furthermore, if Mrs Smith had got remarried to Juan and then divorced, the £500,000 is not her asset but a loan, so the Trust should ensure that is excluded from the divorce settlement. Equally, if she remarried and then died, whilst the rest of the estate may go to Juan, the £500,000 will return to the trust and pass down to the children. The same protection would apply against care costs too.
If your company makes profit through sales, how are those sales generated? If you operate a manufacturing firm, how are your goods produced? If you offer a service, where does that knowledge come from? The answer in all of these examples is through your team of people. Your company relies on its workforce, whether they have experience and knowledge, a powerful influence or a skill set which makes them a valuable commodity. Employing the right people is a struggle in itself, but once you have them, your company can become exceptional and outstanding in its field. Once you have these, you need to keep them. You can do this through the benefits which you provide for them, for example a pension scheme (which has been proven to be the 2nd highest ranked financial benefit of working, next to a salary. But this is not the focus of this chapter; We are going to assume that you already know how to retain your steam. So, the question is, what else could go wrong? What would happen if one of your key team members was taken ill for an extended period? What if someone has an accident which prevents them from working? And what about the worst possible scenario, one of your most valuable members of staff dies? What will happen to your business if one, or more, of your key personnel needs time out of the business?
To put this idea into context, think about this; you insure the building that your business is located in because damages to it would be costly, both to rebuild and repair the physical building, but also so that you do not have to take money out of your company to cover these costs. Likewise, you insure any machinery, company cars, mobile phones, computers…the list goes on. You insure these because you need them in order to operate and because you place a high importance upon them. So why would you not insure the core ingredient that not only makes your business a success, but the aspect of your company that you really cannot do without- your key employees?
One of the biggest risks to your company is the incapacitation of one of your key individuals. The influential, knowledgeable and experienced personnel within your company make your business what it is. If something happens to them, your business will suffer. Illness and death is something that is out of all of our control. However, there is help out there, which will safeguard you and your company;
Keyperson (or person) Protection is fundamentally a type of Insurance for your business. When a company wishes to compensate for financial loss that would arise from a serious illness or death of a key individual, this type of insurance can be taken out. The policy intends to cover the business for any losses incurred and enables the business to continue as before. The policy does not cover actual losses, but instead compensates the company with an income or lump sum that has been predetermined.
In order to show you the importance of Keyperson Protection, we would like to share a case study with you. This case study looks at Phillip Carter who was the Executive Director for Chelsea:
In April 2007, Philip Carter was a non exec director of Chelsea FC. Like his chairman, Mathew Harding, he sadly died with his son died in a helicopter crash coming back from a Chelsea match. His day job was running Carter &Carter– a highly successful business valued at £500 million the day before his death. At the time the share price was £12.75.
Following his death, shareholders and the bank became concerned about the viability of the company going forward and, because of this, the company was thrown into a cash flow crisis, and this quickly snowballed. The shares dropped in value by about 20% on the news of his death, but within six months the shares had fallen to just 85p and were suspended on the stock exchange. In April of 2008, the administrators were called in and the business folded. His widow had been left with a business that was now worth nothing.
Had the company had Key Person Protection, on his death or even serious illness, the company would have received a lump sum of money. This would have given the company time, and the bank confidence, to get the house in order, thus avoiding the company experiencing these problems.
Had the company had Shareholder Protection in place, the company would have had further capital to be able to buy the shares from the widow, leaving the management or other directors to run the company, and giving the widow the capital she needed for her and her family.
Carter’s tale is certainly a deeply upsetting one. The man that had it all financially was set to provide his family with a lifetime of security and comfort. Then tragedy hit and they were left with next to nothing from his extraordinary business. This is a harsh reality for business owners- one day you can have it all and the next it is taken away from you. Unfortunately in life there are some things that you cannot stop from happening, but there are steps that you can take which will ease, if not eradicate, the financial blow and ensure that an unexpected event does not bring your financial plan crashing down.
Keyperson Protection is essential future planning for your business. The smaller you are, the more vulnerable you become to loss due to sickness and death of a key member. Even larger companies with say three managers or directors would be severely impacted if there was a loss of just one person. A sole trader will cease to exist. Keyperson Protection will protect your business and reduce the risk that losses could mean. It could also act as the difference between your family benefiting from your businesses profits or being left with nothing. So let us look at this type of protection in more depth.
To begin with, we will discuss the types of cost that you could be faced with if a key individual was absent from work for a protracted period. If a key person cannot work, you may require temporary staff to cover their role. This would mean that you have the cost of recruitment, additional wages and training. Taking money out of the business to do this may affect your cash flow, which in turn could lead to you not being able to fulfil all of your customer’s orders or needs. You may then be in a position where it becomes a necessity to borrow funds from the bank. Not only could this be a lengthy process, but you are not guaranteed the loan. After all, if the banks are not confident that you can repay the sum, they will not lend it to you. Even worse, the bank may lose confidence in your company and call in the overdraft. This leaves you in a financial conundrum where cash flow has decreased and profits have significantly dropped. This may sound extreme, but it could easily happen. During this time of difficulty, you also need to consider how many customer you may lose, especially how many of them will be pilfered by your prowling competitors.
In order to put this into a real situation, we would like to share an example with you. The aim here is to show you how Keyperson Insurance can help to prevent a catastrophe.
Thankfully, Gill is one of the individuals who are named on the firm’s Keyperson Insurance policy. This means that temporary staff have been recruited to cover Gill’s role and ensure that the customers still receive their orders on time, staff rotas are completed, and the Managing Director still has someone reliable in place to take charge in her absence. Keyperson Insurance pays out the sum assured to cover the costs of recruitment and additional wages
As you can see in the previous example, Keyperson Insurance is a valuable protection to put into place, both for you, your business and your family. The people that can be covered by Keyperson Protection can effectively be anyone who has a significant impact upon your business. For example, they could be the CEO or Executive, departmental manager, a sales person or a head of a department. As a starting point, Keyperson Insurance covers 3 categories of loss:
We are living in an aging population. There are more people over the age of 60 than there are children under the age of 18. In many ways it is a great thing that we are living for longer- it means that we are healthier and modern medical advances are working. It also means that we have more time to enjoy life! However, there are of course some downsides. We will let your imagination think up all the ailments of old age, as for the purpose of this paper we are mainly concerned with one problem; long-term care.
The longer we live, the more care we may require. The current UK state funding aid is limited, and there are no signs of this improving. For many, local council care will be sufficient, but if you would prefer to live your final days receiving the higher level of care and comfort that you would like (and deserve), you must preserve some of your estate to pay for this. Trusts are an option for saving funds to do this. More on long-term care fees later.
If you would like guidance on how you can use Trusts to protect your family’s wealth, we work closely with a number of leading solicitors in this area, and are happy to meet for a free initial consultation to discuss the opportunities available.
Throughout our working lives, most of us strive to earn a good income to provide for our families and enjoy our time. Whether we want our ‘forever home’, the ability to privately educate our children, or even be able to enjoy exciting annual holidays, earning a good income helps us to enjoy our time and lead comfortable lives. But what would happen if that income suddenly stopped? Would you be able to pay the mortgage? Could you afford school fees? Would you even be able to put food on the table?
Whilst none of us can accurately predict the future, that doesn’t mean that we shouldn’t consider life’s unexpected moments and protect ourselves from the unknown.
Imagine you contracted a serious illness or had an accident and couldn’t work. How would you and your family cope? You might have savings set aside for such eventualities, but would they be sufficient? And what if you needed specialist care? Would you want to compromise the security of your family’s wealth so that you could get better?
A quick question: Do you insure your car? I would hope that if you drive you do! I bet you insure your home, pets, holidays, and even your mobile telephones. We insure these things to protect them from the worst. Insurance means that if our kitchen caught fire, we’d have money to repair it; if our faithful four-legged friend broke their tail, we could afford to pay the vet to restore them to full health; if our holiday was cancelled, we wouldn’t be out of pocket.
So why is it that so many of us neglect to insure the most important aspects of our lives? We protect material objects and possessions but forget about our health and our ability to generate an income.
If you take a moment to consider how much you are worth over your lifetime, you are most likely to be the most expensive asset that you own. For example, if you started earning £30,000 at age 20 and this rose with inflation each year (approx. 2.5%), by the time you retire, say at 65, you would have earned £2.5m! If you owned something worth £2.5m would you get it insured? You are darn right you would!
Income Protection is considered to be the most important piece of financial planning by the FCA, as it underpins all of the rest of your strategy. It ensures that if you are unable to work, as a result of illness or accident, you receive an income until either you return to work, or you retire. Unlike policies sold by the banks, like PPI, it is underwritten at the point of application, not the point of claim, which means it is much more likely to pay out when you need it.
If you would like to discuss your options, or reassess any existing plans, we would be delighted to help. At Efficient Portfolio, we believe that protection is one of the most important, yet neglected, areas of financial planning and it’s something we are passionate about improving.
Many of us dream of being able to leave a legacy for our loved ones; whether it is being able to pay the deposit on your grand-daughter’s first house or funding university for your grand-son. Unfortunately simply saving your hard-earned cash is not enough, as there are three risks that could cost your loved ones their inheritance: Long-term Care Fees, Inheritance Tax and Divorce. So what are the solutions?
You are allowed to give away £3000 per year without incurring any Inheritance Tax charges upon your death. Also, if you make a gift and survive for 7 years after making this, it automatically becomes exempt from IHT. The general rule is, before you begin to look at what measures you can put into place, make sure you are taking full advantage of your allowances. There are of course downsides to this, in that you lose all access and control over the money.
Potentially Exempt Gifts (PETs) are sums of money which gifted away in your lifetime, but exceed the £3000 mark. Again, if you survive for more than 7 years after making the initial gift, the sum should be exempt for IHT. However, if you do not, the gift could be subject to a 40% Tax. For some PETs are a great solution, as they are easy and have no administration costs. You also have the benefit from seeing the impact that your gift makes.
Discounted Gift Trust (DGT) are a mechanism where you effectively give up the right to your capital, but still retain the right to receive an income for the rest of your life. This is usually 5% of the total sum that you put into the Trust. Imagine that your estate is a cake. DGT allows you to give away a large portion of that cake, meaning that it leaves your estate and is exempt from Inheritance Tax. This proportion is put into a Trust and you are allowed to keep a slice.
Gift and Loan Trusts (G&L) enable you to reduce your Inheritance Tax bill whilst maintaining full access to your capital. Sadly you cannot simply give away your assets as a gift and then continue to benefit from them; if you do this, the assets which you have gifted are still liable for IHT. However, G&L is a device for legally overcoming this legislation.
This IHT planning solution allows the Settlor to invest their capital into several single policy Life Insurance Bonds or Unit Trusts which are then gifted into the possession of a Trust. These gifts are for the benefit of the Beneficiaries; usually children and grandchildren. However, it is here that this Trust differs to the others; rather than selecting a set percentage to be taken as income, the Settlor retains access to the gifted capital for the rest of their lives. The best bit is that they can specify and change this amount depending on their circumstances.
Business Property Relief is a tax relief provided by the UK Government as an incentive for investing in specific types of trading companies. If you hold assets that qualify for BPR, they will be eligible for an incredible 100% IHT relief on your interest in the business itself.
When it comes to long-term care fees, the key is to achieve the right balance between protecting your wealth for your family and ensuring that you have enough financial support to provide you with comfortable care. When your local authority carries out the means test assessment, money tied up in Investment Bonds will normally be excluded from their calculations. Not only can that, but the returns on Investment Bonds be used to provide a regular income to pay for care-fees. Investment Bonds have an element of Life Assurance with them, meaning that upon your death, the Bond will pay out a slightly more than the value of the fund. This could be put into Trust, to ensure that you are leaving something to your loved ones. The trick with Investment Bonds and Financial Planning in general, is to think ahead to the future. Invest in your Investment Bonds today; do not leave it until tomorrow!
Without question, being a parent has made me realise that I am not the most important person in my life. Giving my kids security and the hope of a bright future is what gets me out of bed in the morning. I fight to succeed everyday so that my children can have a great life. But what if I suddenly wasn’t there or wasn’t able to provide for my family? I wouldn’t want my untimely death or an illness to scupper my daughters’ futures.
Let’s bite the bullet and get the worst case scenario out of the way first. Death only affects those left behind. Despite being one of the only certainties in life, none of us really want to think about it. But come out of your comfort zone and face this fact now. When you die, your loved ones will be the people left behind. What would happen to your family if you suddenly died tomorrow? Would they cope? Would they be able to live out all of their hopes and dreams? Or would they struggle financially? Obviously, they would be affected from an emotional point of view, but how would it affect them financially?
Financial security, peace of mind, an inheritance or just certainty that bills can be paid, are all legacies we’d like to leave behind for our loved ones. A Life Insurance Policy can help to deliver all of these things, so it is a pivotal part of your financial planning strategy. How much you need will depend on your age, wealth and circumstances, but, generally speaking, as a good rule of thumb, you will probably need twenty-five times your income. Why so much? If you earn £20,000, a lump sum of £500,000 will generate a sustainable income of around £20,000 per annum for your loved ones.
The chances of you dropping down dead tomorrow are relatively small. It’s not impossible, and the impact could be huge on your family, but the chances are still slim. Sadly, it’s far more likely though that you could be diagnosed with a critical or even terminal illness.
According to ‘Contractor Weekly’, ‘a recent study has revealed that one in two people born after 1960 will be diagnosed with some form of cancer during their lifetime.’1 These are frightening figures, but those statistics don’t even take into account other life-threatening illnesses that could have a seriously detrimental effect on your finances.
If you are diagnosed with a critical illness, chances are that you would not be able to work for a significant period. If your salary sustains your family, can you image what this would do? They might not be able to pay the mortgage, meet household costs and would generally struggle to get by. Yes, you may be entitled to some form of statutory sick pay, but would this be enough? If you’re self-employed, this problem is compounded even further: If you don’t work, you don’t earn any money.
Many illnesses require specialist treatments, home modifications or professional care, all of which can be very expensive. Say for example that you needed to build a downstairs wet-room, as you could no longer use the stairs. The cost of this would run into the thousands, but would be necessary for you to continue to lead a comfortable standard of living. You may have money put aside to cover this expense, but would you really want to spend your long-term savings on this modification, when it was originally designed to generate your Financial Freedom?
The beauty of Critical Illness Cover is that the payout is tax free and you can spend it on what you need to, whether that is medical bills, your mortgage or home modifications . You are also free to invest the money, so you can build a passive income for your loved ones in the years to come. In other words, Critical Illness Cover will give you a lifeline at this demanding and difficult time. You won’t need to worry about the financial implications of your illness, instead be able to focus on getting better.
The first step in achieving your goals is to discuss your current concerns with one of our qualified Financial Planners.
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