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Funding a Buy-Sell Agreement with Life Insurance

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Funding a Buy-Sell Agreement with Life Insurance

What is a Buy-Sell Agreement? A buy-sell agreement is an agreement between the owners of a business, which provides that the interest of any one of them who dies shall be sold to and will be purchased by the surviving co-owners or by the business at a value agreed upon by the parties and stipulated in the agreement. Life insurance is one of the more popular methods of funding buy-sell agreements today. How it Works

  • In a typical (Entity) Buy-Sell Agreement, the business has an agreement drawn up that spells out what would happen in the event of death (or disability) of one of the owners. Typically, the surviving owners agree to purchase the deceased (or disabled) owner’s interests in the business.
  • Life insurance policies are purchased on each owner’s life, with a death benefit equal to the current value of each owner’s ownership share in the business. Taking into account potential future increase in the value of the business, the business might purchase death benefits greater than current value.
  • The business is the owner of the policy as well as the beneficiary. The business pays the premiums (a non-deductible expense).
  • Upon the death of one of the insured persons, the insurance company pays the (tax-free) death benefit to the business.
  • The business uses the death benefit to pay the estate of the deceased an amount equal to the value of the business interest of the deceased. If additional life insurance had been purchased as key-person insurance, those proceeds would be used by the business to offset the potential income loss resulting from the death of that owner.

Buy-Sell Agreements can be funded with either term or permanent (cash-value) life insurance. Both will pay the death benefit, but the cash value of a permanent life insurance policy can be used for non-death related buy-outs (often in a tax-efficient manner).

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