For many business owners, the company they’ve created is like their child. It’s something they’ve nurtured for years and feel responsible for. And since you wouldn’t leave your child without support if you were to pass away, you don’t want to leave your company high and dry either. One of the ways you can do this is by using your life insurance plan to fund a buy/sell agreement between you and your partner. In this article, we will explain how this works and how you can use this technique yourself to keep your business running even after you pass away.
What is a buy/sell agreement?
A buy/sell agreement is an agreement between co-owners of a business that determines what will happen if one owner were to pass away or choose to leave the business. These agreements are legally binding, and usually are put in place to transfer ownership to the remaining co-owner. The function is similar to that of a will or a prenuptial agreement, but is put in place specifically to deal with this very unique situation.
How to Use Life Insurance To Fund A Buy/Sell Agreement
If you are going to use life insurance to fund a buy/sell agreement, there are several different ways you can do so. The most common strategy is for each co-owner to purchase a life insurance plan for the other one. They each pay the premiums and would be the recipient of a death benefit should the other pass away. The death benefit is then used to buy out the deceased owner’s share of the company. If you decide to use this strategy, you will need to work together to determine what type of policy will be most effective and how much coverage you need. This strategy can be implemented with more than two owners, but you will each need multiple insurance plans.
Another strategy that is commonly used with this type of life insurance agreement is an entity redemption plan. With this strategy, the business purchases life insurance policies for each of the owners, and the payments for the premiums come out of the businesses’ accounts. Each owner has a legal agreement with the business about what to do with their shares should they pass away. If an owner does pass away, the business will receive the death benefit, and they can then opt to use the money to buy the shares back from whoever inherits them. You can combine entity redemption and cross purchase strategies to create a plan that suits your business.
Why Buy/Sell Agreements Are Important
Even if you’re young and healthy, it’s still important to start thinking about what will happen to your business after you’re gone. A buy/sell agreement between business partners ensures a smooth transfer of ownership should anything happen. The last thing you want your business partner to have to deal with in a situation like this is a messy transfer of ownership that affects the way your business runs.
A buy/sell agreement not only provides the legal coverage you need for this situation, but it also lays out a plan for exactly what will happen, so there’s no confusion. This is not only important for your co-owners, but for your employees, family, and customers as well. If you want, you and your co-owners can specify further details about how leadership transition is to be handled in the event of your death.
Using your life insurance policy to fund a buy/sell agreement has a lot of advantages. Depending on the value of your company, it may be expensive for your co-owner to buy out your shares of the business. With an insurance policy in place, they won’t have to worry about this financial challenge, and the transfer of ownership can be handled quickly and efficiently. It’s important that this buy/sell agreement is set up towards the beginning of your company’s existence, and update it over time as needed. You can plan ahead to make sure that your benefits are enough to cover the cost of your shares in the company.
Keep in mind that using life insurance for this purpose won’t cover your funeral expenses or other personal costs that your family might incur as a result of your death. Therefore, it’s a good idea to have a separate policy in place for them. You should also talk with your businesses’ accountant as well as a tax expert when choosing your insurance policies. It’s important that you will consistently be able to afford the premiums, and that you are aware of any tax considerations related to your buy/sell agreement. Your death benefit is free from taxes, but there may be other tax factors to consider depending on the type of business you run.
