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Should You Fund Your Buy/Sell Agreement with Life Insurance?

August 08, 2023

Do you have a plan in place in the event of the death or incapacitation of one of your business partners? A buy-sell agreement will help your business stay afloat. Here’s what you should know.

Without fully-funded buy-sell agreements, closely-held or family businesses face a world of financial and tax problems at an owner’s death, incapacitation, divorce, bankruptcy, sale or retirement. Here’s what you should know.

What is a buy-sell agreement?

A buy-sell agreement is a legally binding contract between the owners of the business which usually provides for the sale of an ownership interest upon the happening of certain events such as death, disability or retirement. The objective of a buy-sell agreement is to provide liquidity to the selling owner; establish a fair market value for the ownership interest under different circumstances; prevent the sale of the ownership interest to third parties; and provide for a pre-determined succession of control and management for the business.

Funding a buy-sell agreement

Life insurance is typically used to fund buy/sell agreements. When using life insurance to fund a buy-sell agreement, either the company or the individual co-owners buy life insurance policies on the lives of each co-owner (but not on themselves). In the case of the death of an owner, the policy owners (the company or co-owners) receive the death benefits from the policies on the deceased owner’s life. That money is then paid in accordance with the terms of the buy-sell agreement to the surviving family members as payment for the owner’s interest in the business.

With a properly funded and executed Buy-Sell, the family gets a sum of cash they can use to help sustain them after the owner’s death, and the company has ensured its continuity.

Advantages of using life insurance

  1. Life insurance creates a lump sum of cash to fund the buy-sell agreement at death.
  2. Life insurance proceeds are usually paid quickly after death, ensuring that the buy-sell transaction can be settled quickly.
  3. Life insurance proceeds are generally income-tax free.
  4. If permanent life insurance is used to fund the buy-sell agreement, and sufficient cash values have built up within the policies, the funds can be accessed to purchase the business interest following an owner’s retirement/disability.

Questions? Contact us.

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