When people think about life insurance, what may come to mind is settling final expenses and providing financial support for your loved ones. But, if you own a business, life insurance can be used as part of a buy-sell agreement. Here is what you need to know about how buy-sell agreements and life insurance work together.
First, what is a buy-sell agreement?
A buy-sell agreement, also known as a buyout agreement, is a legally binding contract stipulating how an owner’s or business partner’s share of the business is reassigned through buying out their shares. Situations that may activate a buy-sell agreement:
- A sale of ownership
- A business exit for another reason
Generally, a buy and sell agreement requires the shares of the business to be sold back to the business, to the remaining partners, or a new owner according to a predetermined formula.
How funding a buy-sell agreement with life insurance works
A buy-sell agreement funded by a life insurance policy helps reduce the negative financial impact that an essential individual’s absence can have on the business. Here’s examples of how funding the buy-sell agreement with life insurance may work in these situations:
Death– Either the company or the individual partners buy life insurance on the lives of each partner, but not themselves. The policy owners (other partners or the business) receive the death benefit when a partner dies. The death benefit is paid to the family or the estate to purchase the deceased partner’s business interests.
Retirement, sale, or business exit– Cash value life insurance is used to buy out a retiring or exiting partner and provide them with retirement income. Or, the partner may choose to have the death benefit paid to their estate or heirs at their death as part of their buy-sell agreement.
Advantages of using life insurance:
- Provides a lump sum of cash to fund the buy-sell agreement at death
- Life insurance death benefits payout promptly
- Partners can use cash value life insurance to buy out another partner using cash
- Cash value life insurance can help fund the retirement of an owner or partner when they exit the business
Disadvantages of using life insurance:
- If the partners’ ages significantly differ, some premiums will be higher than others
- Non-payment of premiums can surrender the life insurance policy
- Some partners may be uninsurable
Life insurance is an essential part of a buy-sell agreement for transferring your shares if you intend to sell your business to partners or other key employees. Using life insurance in a buy-sell agreement should involve a tax professional, a legal professional, and a financial professional to help you determine what type of life insurance is appropriate for your situation.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
This material contains only general descriptions and is not a solicitation to sell any insurance product, nor is it intended as any financial, tax or legal advice. For information about specific insurance needs or situations, contact your insurance agent. This article is intended to assist in educating you about insurance generally and not to provide personal service. They may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. Guarantees are based on the claims paying ability of the issuing company. If you need more information or would like personal advice you should consult an insurance professional. You may also visit your state’s insurance department for more information.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
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