The benefits of a Buy-Sell Agreement funded by life insurance
In a buy-sell agreement funded by life insurance, the individual or co-owners of the company buys life insurance policies of each co-owner. In the event of your death, the co-owners or company will receive the death benefits from your life insurance policy.
A buy-sell agreement is set on the premise that if one of the co-owners of a business dies, he opts to leave or is forced to leave the business. It serves as a business will between business partners and/or the shareholders of a company.
A buy-sell agreement funded with life insurance will give you the confidence and peace of mind that your family and business will still be financially capable when you die. The benefits of a buy-sell agreement funded with life insurance outweigh its costs.
A buy-sell agreement, sometimes called a buyout agreement is a legal agreement between the co-owners of a business.
How Buy-Sell Agreements Funded with Life Insurance Works
The individual co-owners or the company buy each of the co-owners’ life insurance policies when a co-owner of the business dies, the other co-owners or the company is entitled to receive the death benefit due from the insurance policies on the life of the co-owner.
The family of the co-owner who died will likewise receive a cash payment representing the deceased co-owner’s interest in the business.
A buy-sell agreement funded with life insurance provides financial support for the family of the deceased co-owner as well as stability for the company.
Example:
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A co-owner/s of the business pays cash to the heirs of the deceased for his share of the business.
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The shares of the business owned by the deceased owner are transferred by his heirs to the remaining owner.
Types of Buy-Sell Agreements
There are different types of buy-sell agreements funded with life insurance.
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Entity Redemption Plan
The life insurance policies on the lives of each co-owner are purchased by the business. The business also pays for the premiums, making the business the owner and beneficiary of the policies.
Each co-owner enters into an agreement with the business that in the event of his death, the business can buy his shares of stocks and interest in the business.
When a co-owner of the business dies, his shares of stocks will be passed on to his heirs or estate as the case may be. The company then has the prerogative to buy out the inherited shares of the heirs using the proceeds from the life insurance policy of the deceased co-owner.
Example
The business has three owners. The business is valued at $3,000,000 and each of the owners owns 33% of the business.
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The business buys life insurance policies worth $1,000,000 on each co-owner with each owner owning 33% of the life insurance policy.
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When one a co-owner dies, the life insurance company will pay the death benefit to the business.
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The business will give the proceeds of the death benefit to the heirs of the deceased co-owner.
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Cross Purchase Plan
Each owner purchases a life insurance policy on the other owner/s. Each of the owners pays their share of annual premiums. The owners are the beneficiary of each other’s life insurance policy.
When one of the owners dies, the remaining owner receives the death benefit. The remaining owner/s can use the proceeds of the death benefit to purchase the shares of stocks in the company of the deceased owner.
Example
The business has two owners. The business is valued at $2,000,000 and each of the owners owns 50 % of the company.
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Two of the owners of the business buy a $1,000,000 life insurance policy on each other.
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When one of the owners dies, the life insurance company pays the remaining owner $1,000,000 because he is the beneficiary.
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The remaining owner (beneficiary) gives the proceeds of the death benefit to the heirs of the deceased owner.
3. Hybrid Plan
This plan combines the best features of an Entity Redemption Plan and a Cross Purchase Plan.
In a hybrid plan, the owner needs to offer his share of the business to the entity. If for any reason the entity cannot purchase these shares, other co-owners can purchase the shares of one co-owner. Employees and company officials can also purchase the shares.
Example:
The business has two owners. Each owner owns 50% of the $1,000,000 value of the company.
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The business buys $1,000,000 life insurance policy on each owner.
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When one of the owners dies, the insurance company will pay the business $1,000,000 because the business is the beneficiary of the insurance policy.
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The business pays the heirs of the deceased owner $500,000 and reimburses the remaining owner $500,000.
Benefits of a Buy-Sell Agreement
Whether your business is a sole proprietorship, partnership, LLC, or corporation, it is strongly recommended that you have a buy-sell agreement.
Financial planners and business experts will often advise owners of a business to purchase a life insurance policy. This is to make sure that the buy-sell agreement is well-funded. A life insurance policy will also guarantee that the company has the funds to implement a buy-sell agreement.
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The life insurance company is often quick in paying death benefits. If the cash values attached to the life insurance policy is sufficient, the business can accessed the funds to purchase your share when you become disabled or when you retire.
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Regardless of ownership of the life insurance policy, proceeds (e.g. death benefit) are tax-free
Tax Considerations of a Buy-Sell Agreement
Funding a buy-sell agreement with life insurance comes with several tax considerations. The death benefit paid by the life insurance company is typically tax-free, however if the beneficiary is a C corporation business, it will be covered by the alternative minimum tax (AMT).
Other tax considerations may also include:
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The premiums paid by the business for the life insurance policies of its owners or shareholders are not taxable income.
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The premiums paid by the business to fund a buy-sell agreement are not taxable.
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The cash value of the life insurance policy owned by the deceased owner on the other owners’ lives in a cross purchase agreement is considered part of the estate of the deceased. The life insurance policies of the other owners on the deceased life are not considered part of the estate of the deceased owner.
It is best to consult your tax or legal advisor to clarify the tax considerations of a buy-sell agreement.
Getting a buy-sell agreement funded by life insurance will give you the confidence and peace of mind that your family and business will be financially capable in the event of your death. The benefits of a buy-sell agreement funded by life insurance outweigh its cost.