Co-owners or partners in a business should plan for the smooth sale of their business interest after death. This will not only take added stress off your surviving loved ones, but it may also prevent consequential estate taxes. But how will you fund the buy-sell agreement? One option is to fund your agreement with life insurance.
How Companies Can Purchase Life Insurance to Fund Buy-Sell Agreements
The entire purpose of life insurance is to make a lump sum of money available to your family upon your death. However, if you’re a partner in a private business, you can choose to use that payout in a way that may be even more beneficial to your heirs.
To use life insurance for a buy-sell agreement, your company (as an entity) may opt to purchase life insurance policies covering all other owners. This is known as an entity purchase buy-sell agreement. In this type of agreement, the company will pay the insurance premiums.
Ideally, this policy will provide an increasing death benefit on the life of each partner. Then, upon the death of one of the partners, the life insurance benefit payout will be used to purchase the deceased partner’s shares of the business, so that their heirs receive the full value of shares in the business.
How Individual Partners Can Purchase Life Insurance to Fund Buy-Sell Agreements
Alternately, each partner in the business may elect to take out a life insurance policy on other partners in the business, but not themselves. This is known as cross-purchasing. If structured this way, each partner would pay the corresponding premium.
Benefits of Using Life Insurance
Both structures provide the same benefits for your surviving loved ones and for the business. These benefits include:
- A smooth continuation of the business operations
- The federal income tax-free death benefit that becomes available for remaining partners to use to purchase your stake in the company
- An increasing death benefit structure that provides for an increase in the liquidity of the policy, commensurate with company value growth
Considerations When Using Life Insurance to Fund Buy-Sell Agreements
Considerations to weigh when planning for the wellbeing of your business and your loved ones after your passing include the following:
- Ensuring that the agreement is fully funded
- Accounting for changes in business value over time
- Possible negative tax consequences
- Penalties in the event the policy is canceled
Example of Using Life Insurance to Fund a Buy-Sell Agreement
Consider that four siblings equally own a C-corporation with an estimated value of $20 million. Tracy, one of the siblings, passes away. Because Tracy and her siblings purchased an entity-purchase buy-sell agreement, the $5 million death benefit paid out Tracy’s shares. The corporation does not owe Tracy’s estate. Moreover, the value of Tracy’s shares has been protected, and her estate has the necessary liquidity to cover any possible estate taxes.
Is a Life Insurance Policy the Right Way to Fund Your Buy-Sell Agreement?
At Finley Davis, we know that planning for your death can feel overwhelming. We aim to make the process simple. Our team of advisors will present you with a variety of possible plans, and products that can help protect all you’ve worked for, and those you love. To schedule a consultation, contact us today.
