Even if you have personal life insurance with your spouse or family member as the beneficiary, you can still use a separate life insurance policy through your company or co-owner(s) to fund a buy-sell agreement.
Other Goals of a Buy-sell Agreement:
There are many benefits of a buy-sell agreement, including the following:
- Establishing a valuation of a deceased owner’s interest in the business for estate tax purposes.
- Establishing a mutually agreeable price and terms, to reduce potential litigation and friction in the future.
- Helping facilitate the smooth transition of management.
- Making sure the family of the deceased owner receives cash instead of unmarketable stock.
The Basics of a Buy-sell Agreement
A buy-sell agreement is a contract among business owners which, upon the death of one of the owners, requires the remaining owners or the company itself to purchase the deceased’s interest in the company according to the agreed upon terms of the contract. In addition, the deceased’s heirs are required to comply by selling their inherited interest at the previously agreed upon price.
Although there are other options for funding a buy-sell agreement, the smartest method for doing so is through life insurance. This ensures that funds are immediately available when a death occurs; plus, death benefit proceeds are generally income-tax free. In addition, the funds used to buy the deceased’s share are purchased for pennies on the dollar and the premiums will likely be significantly lower than the cost of repaying loan interest.
Types of Buy-sell Life Insurance Plans
There are two main types of buy-sell life insurance plans: cross purchase plans and entity plans.
Cross Purchase Plans
Under this type of plan, the owners enter into an agreement with each other. Each owner purchases a life insurance policy on the other owners, and will be named the beneficiary of the policy. Upon the death of an owner, each surviving owner receives life insurance proceeds income-tax free, heirs receive an agreed upon payment for their business interest, and the surviving owners use the proceeds from the life insurance policy to redeem the deceased owner’s interest in the company.
In this type of agreement, also known as a stock redemption plan, the company purchases life insurance policies on each owner, with the company itself as the beneficiary. When an owner dies, the company receives the life insurance proceeds and uses said proceeds to purchase the deceased’s business interest, while the heirs receive an agreed-upon payment for their business interest.
Offering Protection and Peace of Mind
A chief concern among business owners is what will happen upon the death of one of the owners: how will it affect the business, the other owners and the heirs of the deceased owner? Surviving owners want to ensure the continuity of ownership, and not risk having a large share of ownership fall into the hands of potentially inexperienced heirs of the deceased. In addition, they want to protect themselves and the company financially. On a personal level, owners want to also ensure that their family is financially secure and compensated fairly in case something happens to them. A buy-sell agreement can address all of these concerns.