Business Continuation for Partners – Using Life Insurance with a Buy-Sell Agreement

by Chris Huntley

 

Business partners life insuranceOwning a business takes a lot of hard work, especially in a competitive environment such as we have in the U.S., but the rewards are well worth the effort.

As you build up your business, you have to ask yourself this one very important question.

What happens to my business or my shares in the business should I die or become disabled? 

It is vital you plan for this possibility because the surviving members of your estate could end up being responsible for the fallout.  This is why you should consider Life Insurance for a Buy-Sell Agreement.

What Happens to a Business Owner who Dies or Becomes Disabled?

Without a buy-sell agreement, your heirs would be faced with some very tough decisions to make which could entail some very sticky tax issues.  Their choices would include decisions such as:

  • Being forced to sell your portion of the business and possibly at a loss.
  • Being responsible for existing contracts which they might not be able to fulfill.
  • Continuing to operate the business even though they might not possess the experience to do so.
  • Paying considerable taxes to the IRS if they sell the business.

What is a Buy-Sell Agreement?

A buy-sell agreement arranges for the smooth transition of your shares in the business to your partner(s) if you become disabled or die unexpectedly.  A buy-sell agreement is a contract which is set-up when there are multiple owners and arranges for the transfer of each member’s portion of ownership to the surviving partner(s) as defined in the buy-sell contract.

These contracts require the transfer of funding that should be equivalent to the value each partner’s ownership in the company.  The simplest method to ensure that adequate funding is available for the transfer of ownership as defined by the buy-sell contract is by having a Life Insurance policy specifically designed for buy-sell agreements.

For other types of business policies, see our Business Life InsuranceKey Man Life Insurance, and Cover a Small Business Loan with Life Insurance articles.

Advantages of Life Insurance for Buy-Sell Agreements

The main advantages of having sufficient life insurance for these agreements ensure that:

Your heirs

  • Will get a fair value for your portion of the business and do not have to be worried about complications related to the business.
  • Will receive death benefits for your portion of the business that will be tax exempt.
  • Won’t be bogged down in complicated probate issues when evaluating the estate.

Your partner(s)

  • Won’t have to deal with a new partner which could be the heir.
  • Will be able to continue with the business without a major disruption to their clients,
  • Keep your creditors happy because there will be no significant financial disruptions, and allow for the smooth access to further borrowing if required.

Life Insurance Options for Buy-Sell Agreements

You have a variety of options to consider when setting up an agreement for a buy-sell agreement. The most beneficial way to provide for funding of a buy-sell agreement is through life insurance.  There are two types of life insurance policies you can use and they are:

1. Term Life Insurance

2. Permanent Life Insurance (such as whole life or universal life)

Term Life Insurance

Term Life Insurance covers death benefits only. This type of policy covers for a defined period or term such as 5, 10 or 20 years for example.  It is the cheapest life insurance policy available and may or may not require a medical examination. The death benefits should approximate the equivalent of the value of the percentage owned by each partner or stakeholder in the company.

The main advantage of Term Life Insurance is it affordability.  The main disadvantage is that the amount of death benefits purchased may not adequately cover the increase in the valuation of the business shares of each partner as the business grows and increases over time.  This means additional coverage may be needed down the line to reflect the true value of the company shares, and as partners age, the cost of this type of policy becomes correspondingly more expensive.

Permanent Life Insurance

Permanent Life insurance in the form of Whole Life of Universal Life policies offers a fixed premium that covers the partners for life.  Additionally, there is an attractive cash value feature that grows over the life the policy and has the same tax advantages as death benefits.

Many partners involved in a buy-sell prefer the Whole life policy as they consider the options provided to be more flexible and more attractive in providing an additional tax shelter for retirement investments. As an added option, the cash value can be designated to go a family member instead.

Guaranteed Insurability Options

Additionally, most insurance companies realize that as a business grows, some means had to be provided to allow partners to be able to reflect the growth in the valuation of their shares in the funding agreement. Whether you decide on Term Insurance or Permanent Insurance, you should ensure that you get a policy with a ‘guaranteed insurability option’.

This option allows each policyholder to acquire increased coverage over specified time intervals.

Getting Started with Quotes

If you’re looking for the best price for life insurance to cover a partner in a buy-sell agreement, you can get started by getting a quote using our form on the right or call us directly at 877-443-9467.

*Written by Chris Huntley. Huntley Wealth Insurance and its representatives do not give legal or tax advice. Please consult your own legal or tax adviser.
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Chris Huntley
Chris Huntley is the owner of Huntley Wealth Insurance, a San Diego life insurance agency. You can find him on Google + and Facebook. Over the past 8 years, Chris has consulted with over 2000 individuals about their insurance needs. He is a proud husband and father to three adorable girls.
Chris Huntley
Chris Huntley

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