When Matt and Katie expanded their dairy, they never dreamed they'd need the life insurance their accountant suggested they buy so soon. Six months after the 400-cow dairy was up and running, Matt was killed in a car accident.

Katie was a great cow person, but she wasn't comfortable with the business management side of the operation. Just as they had planned, Katie used the life insurance policy to pay down the farm debt. That gave the business some much needed "breathing room," and gave Katie time to grow into the management role.

Ten years later, Katie and her eldest son - who by the way has become a great cow person - are expanding the dairy again. However, without the life insurance Katie and Matt used as a risk management tool, she probably wouldn't have had time to learn the job before the business failed.

Life insurance is a risk management tool, explains Darrell Dunteman, accountant and accredited agricultural consultant in Bushnell, Ill. You can use it to protect your family, your business and your estate. As with any risk management tool, the key, he says, is knowing how much you need to provide protection without throwing money away.

Use the following steps to determine how much life insurance you need.

Decide why you need it
First, define your purpose in purchasing the life insurance policy, suggests Dunteman. Life insurance is not something you buy and forget about. It's part of your financial plan.

In order to know how much life insurance you need, Dunteman, and David Sousa, certified public accountant in Tulare, Calif., recommend that you ask yourself the following questions:

"Will my heirs need life insurance to pay estate taxes?"
Most farm families do not have enough liquid assets readily available to pay a large estate tax bill. Depending on how the estate is structured, the estate tax bill could run as high as 55 percent of the total value of the estate. Often, as a result, part of the farm gets sold, or additional loans are taken out. Both of these scenarios can be costly.

However, life insurance can be used to cover the cost of estate taxes. Contact your accountant or lawyer to help you examine your liquid assets and to determine the potential tax consequences. Then, have him explain how life insurance can be used to cover this cost. (See the example, "Life insurance can ease the estate tax crunch" on page 74.)
"Will my heirs need life insurance to pay off a large farm debt or house mortgage?"
When a farm business has a lot of debt - especially right after an expansion or for a new startup operation - life insurance can help reduce the risk for your family should something happen to you. Depending on the amount needed to cover the debt, you can opt to buy insurance to cover the debt or to pay it down substantially. This puts the business in a stronger financial position through the transition period.

When deciding how much life insurance you need, don't forget to include the cost of hiring a manager to run the dairy during the transition.

"Do I need life insurance on a business partner?"
If you farm in partnership with one or more people, you run the risk of the partner's heirs demanding immediate payment for their share of the operation - or worse yet, finding yourself in partnership with someone who doesn't want to be there. That's where using a buy-sell agreement funded with life insurance becomes a good tool, says Dunteman.

A buy-sell agreement is a legal contract that outlines what happens to the business should a death, retirement, or dissolution of the business occur. The contract gives the partner(s) first right to buy out another partner or partner's heirs, provides a method of valuation, defines the terms of payment and establishes a method of arbitration, if necessary. Using life insurance to fund a buy-sell agreement gives you the cash needed to pay the partner's heirs.

"Do I need life insurance to provide an equitable estate to children not involved in the business?"
When developing a plan to pass the farm business on to the next generation, the question producers most commonly struggle with is how to treat non-farm children equitably without jeopardizing the future of the business, says Sousa. When you leave the farm to the next generation, the children not involved in the farm could force the sale of the business in order to collect their fair share right away. That often leaves the children involved in the farming operation with few options to raise the cash needed quickly.

Life insurance can alleviate this problem. You can use life insurance to provide a cash payout to the non-farm heirs and leave the farm operation to the children who want to continue the business.

"Do I need life insurance to support my spouse and children?"
Using a life insurance payout to support a surviving family is the first use people think of when deciding how much life insurance to buy. However, as with any other use for life insurance, you must consider several factors in order to decide how much you need.

First, you'll need to decide if you want to purchase enough life insurance for your family to be set for life, or to cover the major bills - such as college tuition or a home mortgage - and support the family through a three- to five-year transition. More and more producers use life insurance as a transition tool, says Sousa. Doing so means a lower cost for the life insurance and it meets the intended goal.

To decide which is best for you, ask yourself the following:

  • Is there any disability which prevents your spouse from working?
  • Does your spouse currently work? On farm or off farm?
  • Until what age will your spouse work?
  • Do you have children who still plan to attend college?
  • How many years will the children need financial support?
  • Do you already have funds set aside for retirement, or do you need to do so now for your spouse?

Calculate your needs
Now that you've examined the reasons why you might need life insurance, the next step is to calculate how much you need. Use the life insurance planning worksheet at right to examine your financial position and level of risk.

Once you've done some initial calculations, contact your accountant or lawyer to help you sort through the details and determine the appropriate amount of life insurance you need to protect your family and your business.

Then, with each major financial change in your life - the birth of a child, the purchase or sale of land, a dairy expansion, or a child graduating college - you'll need to recalculate your life insurance need, stresses Dunteman. As your financial outlook or equity position changes, so to does the amount of life insurance needed to limit your risk.

And remember, you can reach a point where you no longer need life insurance.

Change in law will raise insurance rates

Changes in the insurance industry, set to take place next January, are predicted to increase the cost of term life insurance.

The regulation change, proposed by the National Association of Insurance Commissioners in March and which must be approved by individual states, requires insurance companies to maintain higher cash reserves in order to provide longer, stronger guarantee features for term level policies, explains Dave Sousa, accountant, Tulare, Calif. This change will increase the cost for insurance companies, which, in turn, will increase policy premiums.

So, if you've been thinking about new coverage, or increasing your coverage, contact your accountant or lawyer to discuss before the rates increase.