What is buy sell life insurance?
Buy sell life insurance is a term used for issuing life insurance protection for a business.
The death of a business owner or partner can be a uncertain time for the life of a business. A buy-sell agreement can help protect a business owner and their business from the effects of unintended transfers of ownership.
How does buy sell life insurance work?
In simple terms, the buy sell agreement spells out what happens to the ownership interests of a business partner who dies. Life insurance provides money for a buyout if one of the partners die.
Who can benefit from buy sell life insurance?
From modest family operations to multi-billion dollar corporations. The death of an owner can seriously cripple a business. Buy sell life insurance allows for a smooth transition in ownership to the surviving owners.
Without the buy sell life insurance, the heirs of the deceased owner will inherit those shares of the company. They then can sell the shares of the business to anyone. This could force important decisions about how the company is run to people outside of the surviving shareholders control.
A heir of the deceased might not want to be a part of the business. A Buy sell life insurance agreement allows the deceased heir to turn their inherited interest in the business into cash. This frees them from the burden of taking on the role of an owner of the business.
By planning ahead with buy-sell life insurance, you can avoid the unnecessary hardship on both the family and remaining partners.
The business can continue to succeed into the future, and avoid lengthy probate court and lawsuits.
Why use life insurance?
Creating the buy-sell agreement only protects the business partially. For complete protection, the surviving owners must have funds available to buy the deceased’s portion of the business from the heirs.
This may mean borrowing the funds at an expensive interest rate. It could mean liquidating business capital that is still needed by the business. Sometimes partner’s are forced to use their personal property-homes, cars, etc. as collateral on a private loan.
And ultimately, if none of these options work, the heirs of the deceased are left with shares in a business they don’t want, and no inheritance.
Life insurance is a cost-efficient, relatively simple way to do this, and the funding may not only be guaranteed but generally tax-free.
Different types of buy sell life insurance agreements
There are two ways a buy-sell agreement can work. One is a cross-purchase agreement. With the cross purchase agreement each owner signs an agreement called the buy-sell agreement. This agreement is drawn up by an attorney, not an insurance agent.
This agreement obligates the surviving owners to buy the shares of the company from the heirs of the owner that passes away. Next, each owner pays for and is beneficiary of life insurance on the other owner’s lives.
Finally, upon the death of an owner, the surviving owners receives the life insurance death benefit payments, and uses that money to buy the shares of the business belonging to the deceased heirs.
The second type agreement is the entity purchase agreement. Again, first the company and owners sign a written buy-sell agreement. This time though the agreement obligates the company to buy the shares of an owner upon death.
Then, the company purchases, owns, and pays premium on a life insurance policy on each of the owners.
The company is names as the beneficiary of that life insurance policy. Upon the death of an insured owner, the company receives the death benefit payment, pays the deceased heirs, and transfers the business interest back to the company.
The choice between a cross-purchase agreement and a entity purchase agreement buy-sell agreement will depend on the specific situation of the company. Their are advantages and disadvantages of each approach. An attorney can help determine which agreement is best for each situation.
Example of a buy-sell life insurance situation
Joe and Tom are equal part shareholders of ABC, Inc. a large auto parts distributor set up as a C-Corporation.
ABC, Inc. has been in business for a little over a decade, and Joe and Tom are both very involved in the day to day operations of the business. Joe manages the books and buying functions that keep the products on the shelf for the company.
Tom manages the staff of about 15 organizing schedules, and overseeing the advertising and promotional activities.
As the business continues to grow Joe and Tom decide it’s time to engage in some business continuation planning in the event one of them unexpectedly passes away. Both owners are married and have built the company from the ground up. None of their children are interested in the business.
After meeting with their attorney and drafting a buy sell agreement, Joe and Tom receive quotes for life insurance an apply. They each apply for $1 million of protection representing their share of the company. They each decide to purchase 30 year guaranteed level term life insurance.
Since Tom is several years older than Joe and has some health problems they decide to use the entity purchase agreement. This is because Tom’s premium will be considerably higher than Joe’s premium.
The cross purchase would create a much higher premium cost for Joe since Tom is older and has some health conditions. With the entity purchase agreement the premium cost is paid by the corporation thus making it a more equitable purchase.
The trigger of the buy sell life insurance agreement
Building the business for years has been a lot of hard work. Five years after the agreement and life insurance coverage was placed in force, Tom has a major heart attack and passes away.
Thanks to the buy sell agreement the business is named as beneficiary and is paid Tom’s share of the death benefit. With the life insurance money Joe purchases Tom’s shares from his heirs. Joe now owns 100% of the business and Tom’s heirs have cash for Tom’s share of the business.
Buy sell life insurance is an easy and affordable way for business owners to protect their business. If you would like to discuss how these solutions might help you, please contact us at 1-888-393-9003 or mike@specialriskterm.com
