Benefits of Funding Buy-Sell Agreements With Life Insurance

Business Owners:
The Benefits of Funding Buy-Sell Agreements Using Life Insurance

• Can Your Business Survive Without You?
• What Would Happen To Your Partners, Employees, Or Family?
• Is There a Business Continuation Plan In Place to Prevent Disruption Or Destruction?

If you don’t have the answer to the top 3 questions many business owners face, this article is intended for you. It’s not meant to be a doomsday scenario; it is simply a stark reality that business owners must face in the event of their death or long-term disability. Could business partners, employees, or your family, afford to go on or will your death sound the death knell for the business? A life insurance funded buy-sell agreement may be the rescue plan you need to put in place to prevent potential financial problems that would ruin your business. This article is meant to give you a simple explanation of the concept of these contracts, not to provide legal advice. The information we give you should spark questions to run by your attorney or tax specialist.

Definition of a Buy-Sell Agreement

A buy-sell agreement is essentially a legal contract between co-owners, shareholders, or partners usually in a closely-held business, commonly called a “buyout” deal, or even a “business last will and testament.” If a co-owner dies or is forced to leave the business or lets says he simply wants to end the partnership, then this type of agreement dictates the financial transition.

Funding a Buy-Sell Agreement With Life Insurance

When a buy-sell agreement is funded with life insurance, the company or the individual co-owners buy life insurance policies on each other’s lives. If you die, the company or the co-owners receive the death benefit proceeds from the insurance policies. Additionally, the family of the deceased owner receives the cash payment for his/her interest in the business. Depending on the circumstances, these proceeds might be tax-free. This provides financial support for the heirs after your death, while also providing financial stability for the company’s future.

Common Buy-Sell Agreement Options

Cross-purchase plan:

This is where shareholders, co-owners, or partners in a business personally purchase, own, and pay the life insurance policy premiums on the life of the others. When any of the owners die, the surviving owner/partners have the death benefit payment at their disposal to buy out the share of the business. This is usually dictated by a legal agreement put in place by company legal advisors.

Entity purchase or stock redemption plan:

As a part of this agreement, the business will purchase separate life insurance contracts on the lives of the owners. The premiums are paid by the business. Therefore the business itself is an owner and beneficiary of the life insurance policy. The company is basically buying the stock back from the heirs and paying them for those shares. The stock is usually retired, thereby making the remaining stockholders’ shares more valuable. There are many versions and combinations of these plans.

Hybrid plan:

A hybrid plan combines the first two types of buy-sell agreements. In this type of plan, if the entity refuses to buy the ownership interest then the shares are offered to other co-owners or partners to buy. This type of arrangement presents certain employees like longtime company officials with an opportunity to purchase the interest.

Tax Consequences of Buy-Sell Agreements

• The life insurance premiums used to fund a buy-sell agreement are not tax deductible.
• In a Cross-Purchase Agreement where an individual shareholder purchases life insurance on the life of another shareholder and pays the premium, it is paid for with after-tax dollars.
• Life insurance proceeds are generally tax-free to a beneficiary, but it depends on the agreement structure.

It is critical that you consult with your tax advisor or attorney to provide specific advice regarding the tax implications of a buy-sell agreement.

Buying Peace of Mind with a Buy/Sell Agreement

• Provides money to assure business continuation or dissolution at a fair market value
• Provides revenue to pay back debt and satisfy creditors
• Assures heirs receive cash for the fair share of the business

Let’s have a look at Pros and potential Cons of a life insurance funded buy-sell agreement for your business:

Pros:

• After the death of an owner, remaining owner/partners have available cash to buy out his/her shares.
• The family of the deceased owner receives income from the life insurance death benefit payout while preventing those family members from becoming inadvertent business partners unless those were the wishes of the deceased partner.
• The family generally receives the death benefit proceeds income tax-free.
• Creates quick cash assets for the business to reorganize, and/or pay back debt to creditors.

Potential Cons:

• Disagreement among business partners due to lack of knowledge or misunderstanding about the need or type of buy-sell agreement for the particular business structure. This could damage trust among co-owners.
• The cost of life insurance policy premiums could put a dent in the business’ revenues; especially if any of the owners have high-risk health issues that can significantly increase premium rates.
• Coming to an agreement among partners as to the true value of the business in determining how much term life or permanent insurance to purchase to assure business operations can go in the absence of the deceased owner/partner.

To draft the proper agreement that satisfies all owners and avoids future conflict, the owners need to understand their goals and any tax implications of the transaction. Your first step in determining the complexity of funding a buy-sell agreement with life insurance is to consult a Certified Public Accountant (CPA), or attorney who can help clarify owners’ choices and who fully understands your business operations.

You have nothing to lose in comparing policies from top-rated insurance carriers with one of our unbiased, licensed life insurance professionals. It only takes a couple of minutes to obtain a free, no-obligation instant life insurance quote from numerous companies to compare side-by-side. Some have more lenient guidelines than others on common medical conditions that can keep the cost of the policies down, i.e., depending on the current health of the co-owners. That’s why experience counts and will be worth your time to connect with one of our specialists.