When entrepreneurs are excited about growing their business, drafting a buy-sell agreement is less fun than closing the next big account, but it should still be a high priority.
Many successful partnerships have formal buy-sell agreements using life insurance to divide the business shares upon the death of a partner.
We will provide insightful information on the complexities of buy-sell life insurance to help you make a more informed purchasing decision.
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How Does a Buy-sell Agreement Work?
A buy-sell agreement is essentially a business owner’s version of a prenuptial agreement. It serves as a safety net in case unfortunate events like death, disability, or disagreements occur within the business.
Having this agreement in place it ensures that financial burdens are minimized and the transition of the business remains smooth and stress-free.
In a buy-sell agreement, partners agree to sell their shares according to a predetermined formula either back to the company or to the remaining partners of the business.
An insured buy-sell agreement takes it one step further by utilizing a life insurance policy as its funding source. The death benefit from this policy is used to purchase the deceased partner’s interest in the business.
When a death occurs, control over these interests must be transferred according to the terms outlined in the buy-sell agreement from the deceased partner’s heirs to the surviving partners.
One major advantage of having buy-sell insurance is that it relieves surviving partners from having to sell off company assets to raise cash.
Instead, they can rely on immediate cash benefits provided by life insurance proceeds. This allows them to continue normal operations without involving external family members or investors.
Types of Buy-Sell Agreements
Life insurance is a crucial component of buy-sell agreements, as it helps businesses navigate unexpected transitions smoothly.
Life insurance provides a solid game plan that ensures fair payouts without financial strain or disputes.
Setting an undisputed purchase price is essential, and a fair market valuation can help prevent emotional conflicts during ownership changes.
There are two main strategies to consider: cross-purchase and stock redemption plans. Choosing the most straightforward option for your business structure will provide mutual assurance among owners.
Cross-Purchase Buy-Sell Agreement
Cross-Purchase Buy-Sell AgreementA buy-sell cross-purchase agreement is the most popular structure for most small companies.
A cross-purchase buy-sell agreement requires that each owner buy a life insurance policy for the remaining partners. Typically, the death benefit equals each partner’s share in the small business.
Each owner will be the beneficiary, premium payor, and owner of each policy they purchase on the lives of the other business owners.
A cross-purchase plan explains how the deceased partner’s heirs will sell their interest to the surviving owners with the buy-sell insurance proceeds.
A buy-sell cross-purchase agreement has a distinct tax advantage compared to other insured buy-sell arrangements.
With this type of buy-sell contract, the family of the deceased partner’s tax basis will be equal to the fair market value at the time of death.
Is life insurance tax-deductible if you purchase life insurance policies for your partners?
Unfortunately, you can not deduct the life insurance premiums you pay for buy-sell coverage as business expenses, according to Investopedia.
However, the life insurance death benefits paid to beneficiaries are free from federal income taxes compared to making a direct payment by the surviving partner.
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Case Study:
Cross-Purchase Buy-sell Agreement:
Here is a sample buy-sell agreement for a partnership between John and Tom.
John and Tom have a successful two-person partnership with a current business valuation of $2,000,000.
To ensure the company’s continued success, a separate life insurance policy is purchased for each partner’s share based on the value of the business.
In a business worth $2,000,000 with two partners, each life insurance policy would be $1,000,000.
The beneficiaries of the insurance would be each partner’s heirs.
In the event of the death of either partner, the buy and sell agreement is activated, and the $1,000,000 insurance policy is used to buy out the deceased partner’s share.
Stock-Redemption Buy-Sell Agreement
First, a stock redemption plan is often referred to as an entity purchase agreement.
What is a stock redemption plan?
The company buys life insurance policies for each owner in a stock redemption agreement.
If a shareholder dies, the company buys the deceased owner’s share from their heirs with the death benefit.
With an entity purchase agreement or stock redemption plan, the deceased shareholders’ families receive immediate liquidity at fair market value for their share of the business.
Stock-redemption agreements are much easier to monitor with several partners because only one policy per partner is required.
The company pays for the difference in life insurance premiums due to varying partners’ ages, health, and gender.
The company will pay for the premiums, be the policy owner, and benefit from each life insurance policy in a stock redemption plan.
Entity purchase vs. cross-purchase, which is better?
The entity agreement has the disadvantage of not giving the surviving partner a step-up in basis when the corporation purchases the deceased partner’s interest.
So, stock redemption plans are subject to higher capital gains taxes than cross-purchase agreements if their shares are sold before death.
Wait-and-See Buy-Sell Agreement
Wait-and-See Buy-Sell AgreementWith a Wait-and-See Buy-Sell Agreement, business partners can postpone selecting an entity purchase or a cross-purchase buy-sell agreement until after the actual death of a partner.
The agreement allows the business to purchase the surviving family member’s interest.
The cross-purchase option is usually activated if the company does not make the purchase.
Many wait-and-see agreements may also have additional options if the cross-purchase option is not utilized.
Buy-Sell Agreement Insurance Set Up
Pay attention to every detail and ensure all requirements are met to guarantee enforceability and avoid potential legal disputes.
A critical aspect of a buy-sell agreement is establishing a clear timeline that outlines the necessary actions and their deadlines after specific events occur, leaving no room for surprises or confusion.
Another necessary decision involves determining who should own the life insurance policy. This choice not only impacts control but also has tax implications.
Moreover, setting prices for future transactions by implementing a well-defined formula based on fair market value principles. This approach ensures transparency and fairness when purchasing shares from departing stakeholders.
As you can see, crafting a comprehensive buy-sell agreement requires careful consideration of timelines, decisions regarding life insurance policies ownership structure, and establishing fair pricing mechanisms for future transactions.
Affordable Life USA collaborates with attorneys, accountants, and valuators to facilitate life insurance buyouts for our clients.
- Attorney: A buy-sell agreement is usually drafted by an attorney, who ensures the agreement protects each owner’s interests.
- CPA: Accountants will help with the possible income tax issues for the buyer and seller and the tax implications for the business.
- Valuator: A business valuation specialist can explain how the partners determine the price in a formal buy-sell agreement.
- Life Insurance Agent: A life insurance agent is needed to assist you with funding your buy-sell contract.
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Qualifying for Buy-Sell Life Insurance
Securing buy-sell agreement life insurance can be challenging when partners have different health and age profiles. The cost of premiums depends on various factors like age, medical history, and family background.
Younger and healthier partners may only need a telephone interview to obtain coverage, while older partners might require a medical examination for a new policy.
Unfortunately, senior partners face higher premiums due to their age compared to their younger counterparts.
To ensure successful funding of your buy-sell insurance policy, working with an agency that specializes in addressing diverse health issues is crucial.
We aim to help you navigate the underwriting process effectively and find the best type of coverage for your company’s life insurance buyout.
Term Life Insurance for Business Partners
Buy Sell Life Insurance Rates
| $500k | $750k | $1mm | |
| Age | 10 | 10 | 10 |
| 30 | $15 | $20 | $22 |
| 40 | $19 | $25 | $29 |
| 50 | $42 | $64 | $75 |
| 20 | 20 | 20 | |
| 30 | $21 | $27 | $33 |
| 40 | $28 | $41 | $52 |
| 50 | $73 | $108 | $142 |
| 30 | 30 | 30 | |
| 30 | $32 | $47 | $58 |
| 40 | $53 | $76 | $99 |
| 50 | $125 | $185 | $252 |
At Affordable Life USA, we aim to assist entrepreneurs in finding an affordable term insurance plan that meets your company’s specific coverage requirements.
Utilize our user-friendly calculator to compare business life insurance rates based on your age.
Our online comparison tool guarantees a time-saving and effortless experience in locating the perfect policy for you.
Permanent Life Insurance for Partnerships
Permanent life insurance is a more expensive policy with the advantage of accumulating cash value.
Permanent coverage, such as universal and whole life, also protects for a business owner’s entire lifetime.
The life insurance premiums will become an ongoing business expense and must be paid annually to maintain coverage.
The cash values can also fund a portion of a buy-sell agreement if someone leaves the company for a reason other than death.
This policy may be appropriate for younger partners because, over time, the accumulated cash value may be used to fund a future buyout of a partner.
Life Insurance for Business
Life Insurance for BusinessWe have developed a disciplined process to assist successful companies with their personal and small business life insurance needs.
When reviewing your buy-sell insurance, we can often look at other business planning strategies. Here are a few ways we can typically assist small business owners with life insurance.
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Key Person Life Insurance policy
Successful companies buy key person life insurance on their valuable executives to provide the company with money in the form of a death benefit if they should die.
A keyman life insurance policy provides the funds to compensate for lost revenue, train a replacement employee, and pay off the unpaid loan balance.
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EXECUTIVE BONUS LIFE INSURANCE
Company owners can attract and reward top executives by furnishing an Executive Bonus Life Insurance Plan.
The business will bonus an employee to pay the premiums on a life insurance policy to benefit their family. The worker will own the policy, and their family will receive the tax-free death benefit.
The family could use the death benefit to replace the executive’s lost income because they no longer work for the firm.
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Business Loan Life Insurance
Banks and many angel investors generally require a company to buy a term insurance policy on the business owner to secure these funds.
Having an active life insurance policy while paying off the business loan increases your company’s credibility and relieves stress for both owners and lenders.
When life insurance for the SBA loan policy is in place, the bank will be the beneficiary on a collateral assignment form.
FAQ: Buy-sell Agreement Life Insurance
FAQ: Buy-sell Agreement Life InsuranceWhat is the difference between personal and business life insurance? Personal life insurance protects your family. Purchasing a separate policy designed for your business ensures that your company is adequately protected in unforeseen circumstances.
Are buy-sell agreement life insurance premiums tax deductible? Premiums paid for a buy-sell agreement cannot be deducted, regardless of whether the corporation, shareholders, or a third party owns the policy.
What is the best insurance for buy-sell agreements? When considering business coverage, there are two options: permanent and term life insurance. The choice depends on the specific needs of your business. Term policies work well for short-term requirements, while permanent coverage suits long-standing needs.
What are the disadvantages of a buy-sell agreement? Some drawbacks of a buy-sell agreement are high costs, complexity during setup, and potential tax complications depending on your circumstances.
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Affordable Life USA is dedicated to providing comprehensive life insurance solutions to families and business owners throughout the United States.
For over thirty years, our agency has provided a platform for comparing hundreds of life insurance policies without the stress of high-pressure sales tactics.
Our experienced team of financial planners has helped thousands of clients obtain affordable coverage through our efficient online application process.
Our founder, Eric Van Haaften, expanded our consumer-centric sales model nationally by leveraging the influence of renowned publications such as Time, Newsweek, and The Wall Street Journal.
Eric acquired his love for quantitative analysis while getting his business degree from Ferris State University, which provided a solid foundation for his analytical approach to financial planning.
Eric Van Haaften, LUTCF
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