Can life insurance collateralize business bank debt?

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How banks view lending money to business owners.

Banks follow established rules, which include asking a business owner to collateralize a loan, not just with business assets but also with personally owned assets, such as a principal residence and cottage. Collateralization can require collateralising a spouse’s co-owned assets, even if the business is incorporated.

Add to that a possible collateralization of any assets of a partner or adult child (and their spouses) who also share in ownership. Small business owners can lose their shirts if they default on a loan.

What if an owner dies? It is unwise to assume that a good relationship with the bank will continue if the heir of a small business or a partner is not in favour with the bank manager. Bank managers can change or apply strict policies while reassessing the leniency shown to previous owners or administrators.

Eliminate doubt in a family business, such as a farm, by insuring the oldest owners and succeeding generations using joint-first-to-die policies or individual life insurance policies. In the case of a non-family business, each owner/partner should be insured to cover the company’s debt. When the life insured dies, the tax-free life insurance proceeds can be used to pay back loans, win back ownership, and discharge any personal assets liens.

What if there is a critical illness? For the same reason, small business owners should consider purchasing a critical illness (CI) insurance policy for each principal business owner and key persons. CI insurance could pay off a considerable bank debt if one were to experience a significant illness such as a heart attack or stroke. One could become incapacitated and need to be bought out by a partner or an heir (there should be a buy-sell agreement in place). The risk of a loan being called increases when an owner-manager is sick, and the bank manager loses confidence in the debt-paying influence of that owner.

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Life Insurance policies vary according to contract terms. Please read any Life Insurance policy contract provided, or the segregated fund summary information folder prospectus before the time of purchase. Full details of coverage, including limitations and exclusions that apply, are set out in the policy of insurance. Commissions, trailing commissions, management fees and expenses may be associated with segregated fund investments which may not be guaranteed and their market value changes daily and past performance is not indicative of future results. A description of the key features of a life insurance policy, a segregated fund; and any applicable individual variable annuity contract is contained in information provided by the company from which it is purchased. Talk to your advisor before making any financial decision. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors. The information provided is accurate to the best of our knowledge as of the date of publication and is general in nature, intended for educational purposes only, and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors. Rules and their interpretation may change, affecting the accuracy of the information.

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The comments contained herein are a general discussion of certain issues intended as general information only and should not be relied upon as tax or legal advice. Please obtain independent professional advice, in the context of your particular circumstances. This content was prepared by Adviceon® for the benefit of the advisor Gary and Amanda Attack who are a Investment Funds Advisors at Gary H Attack Financial Planning a registered trade name with Investia Financial Services Inc. a registered trade name with Investia Financial Services Inc., and does not necessarily reflect the opinion of Investia Financial Services Inc. The information contained in this presentation comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability.