Using Life Insurance to Fund a Buy-Sell Agreement

A chief concern among businesses is how the death of an owner will affect the business, other owners, and the heirs of the deceased. Surviving owners want to ensure continuity of ownership, protect the business’s finances, and ensure that the decedents' family is compensated fairly for their ownership interest.

A buy-sell agreement can help address these concerns.

What Is a Buy-Sell Agreement?

A buy-sell agreement is a contract among business owners that, upon the death of one of the owners, requires the remaining owners or the company itself to purchase the deceased’s interest according to the agreed-upon terms. The deceased’s heirs must comply by selling their inherited interest at a previously agreed-upon price.

Funding a Buy-Sell Agreement

The best way to fund a buy-sell agreement is through life insurance. This ensures that funds are immediately available when a death occurs. Death benefit proceeds are generally income tax-free.

These tax-free funds

• ensure the family of the deceased receives cash instead of unmarketable stock and
• protect the company’s liquidity needs at a potentially vulnerable time.

Key Advantages of a Buy-Sell Agreement

A buy-sell agreement is crucial in maintaining business stability during ownership transitions. Without proper planning, a business owner's sudden death can harm the business and have a significant financial impact on the owner’s family. A properly structured business continuation or succession plan (a buy-sell agreement) funded with life insurance can help minimize these impacts.

Buy-sell agreements offer several key advantages:

• Establish a valuation of a deceased owner’s interest in the business.
• Set a mutually agreeable price and terms to reduce potential litigation or friction.
• Facilitate a smooth transition of management.

Structuring a Buy-Sell Agreement with Life Insurance

The two primary forms of buy-sell agreements are:

• Cross-Purchase Plans: Each owner purchases a life insurance policy on the other owners and is the named beneficiary. Upon the death of an owner, each surviving owner receives the life insurance proceeds income tax-free and uses the proceeds to purchase the deceased’s business interest. The heirs of the deceased receive an agreed-upon payment for their inherited business interest.
• Entity Plans: The company purchases life insurance policies for each owner, naming itself as the sole beneficiary. Upon an owner’s death, the company receives the life insurance proceeds and uses them to purchase the deceased’s business interest. The deceased’s heirs receive an agreed-upon payment for their inherited business interest.

Many businesses find life insurance the most financially viable structure for a smooth ownership transition. Hylant understands the complexities of buy-sell agreements and how to structure the policies needed to fund these agreements. We help you protect your business, assets, and family. Hylant can assist with easing your concerns about funding these transitions while remaining cost-effective for the organization.

If you have questions or want help, contact Hylant today.

Related Reading: Tax Liquidity Planning

The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.