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Different perspectives on risk planning for business owners

01 April 2013 Jaco Gouws, Old Mutual

When performing financial planning for business owners, one would place more emphasis on permanent disability cover solutions such as lump-sum disability products than on temporary disability solutions like income disability products.

Some important questions that need to be considered when performing proper financial planning for business owners include:
• What is the impact on the business should one of the directors be involved in a serious motor vehicle accident and consequently not be actively part of the day-to-day income generating activities of the business?
• Will employee salaries still be paid at the end of each month if the business owner is unable to contribute to the monthly turnover of the business due to an illness or injury?
• Does the business have access to an overdraft facility to pay the monthly business expenses?

A Business Overheads Replacer Benefit specifically addresses these concerns. It is a tax-deductible benefit that provides cover for business expenses in the event of partial, full or temporary disability. The benefit covers key individuals who contribute to the businesses turnover and continuity.

Key persons retiring or resigning?

Which proactive plans can a business put in place to reduce the risk if a key person resigns, retires, is disabled or – even worse – dies?

Business owners often underestimate the relationships forged between key individuals and their business clients. The loss of a key individual could have a negative impact on the business’s ability to make a profit and retain clients. A restraint of trade could offer only a partial solution to some of these challenges.

Other solutions include structuring a Preferred Compensation Agreement by combining a savings benefit with the business cover benefits to address the retirement and resignation risks.

This ensures that:
• The retirement and resignation risks are addressed should the key individual resign;
• The company will be able to use the accumulated capital as an interim cash flow solution until a suitable successor is appointed;
• An incentive is created for the key individuals to remain in service as there is a capital reward at the end of a predetermined period; and
• There is a tax advantage for the employer, since this is a tax-deductible arrangement, provided it is structured as part of their payroll and that employee salaries qualify as a business operating expense.

Aligning risk solutions with SARS

The South African Revenue Services (SARS) issued two practice notes on the estate duty for key person and business contingency policies. If one reads section 3(3) closely, it states that the proceeds of the policy will be exempt if it was not taken out "on the instance of the director". This could become a contentious issue at claims stage, when it is too late to rectify.

In order to comply with the aforementioned section, some financial planners may recommend that a meeting be held regarding the decision to take out a risk policy on a particular director’s life without that respective director being present at the meeting – meaning the policy will not attract estate duty. The problem with this route is that if the founding statements of the company clearly state that there must always be a unanimous decision taken by directors it could challenge this arrangement.

How many financial planners actually check the founding statements for this requirement? Clearly this is definite motivation to increase cover by an additional 20% to ensure that there are no shortfalls at claim stage and this must be highlighted to any prospective corporate clients.

In summary, the following questions need to be considered to ensure continuity of the business:
• Will possible resignation or retirement of this individual have an impact on the business’s profitability and continuity?
• Are you interested in a tax-efficient option, which will provide an income stream for business expenses should the business owners be unable to generate business income for a short period?
• Will you be able to prove that a company-owned policy will not attract estate duty?

‘To ensure future business continuity, a different perspective is needed – if the relevant risks are not addressed, the business owner might unnecessarily be left exposed!’

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