When using life insurance with a Buy-Sell Agreement, either the company or the individual co-owners buy life insurance policies on the lives of each co-owner (but not on themselves). If one of those covered dies, the policy owners (the company or co-owners) receive the death benefits from the policies on that life. That money is paid to the individual's surviving family members as payment for their interest in the business. This policy ensures that the family receives a sum of cash they can use to help sustain them, and the company has ensured its continuity.
Life Insurance Advantages
Different Types of Buy-Sell Agreements
In an entity purchase buy-sell agreement, the business itself buys separate life insurance policies on the lives of each of the co-owners. The business usually pays the annual premiums and is the owner and beneficiary of the policies.
In a cross purchase buy-sell agreement, each co-owner buys a life insurance policy on each of the other co-owners. Each co-owner usually pays the annual premiums on the policies they own and are the beneficiaries of the policies. If your company has a large number of co-owners, multiple policies must be purchased by each co-owner.
A wait and see (or hybrid) buy-sell agreement allows you to combine features from both the entity purchase and cross purchase models. The business can buy policies on each co-owner, the individual co-owners can buy policies on each other, or a mixture of both methods can be used.
Buy-Sell Agreements Should Be Fully Funded
The amount of insurance coverage on your life should equal the value of your ownership interest. Then, when you die, there will be enough cash from the policy proceeds to pay your family or estate in full for your share of the business. But if all that is affordable is insurance coverage for a portion of your interest, you might want to go ahead and fund that amount. Later, the company may be able to increase the amount of insurance or use additional funding methods. In the meantime, the agreement should specify how your family or estate will be paid.
When The Business Value Changes Over Time
If the insurance proceeds are less than the value of your business interest, due to growth in the business? The surviving family members might end up with more than or less than full value for your business interest. The buy-sell agreement should specify how the valuation difference will be handled.
Using a company's group life insurance plan to fund a buy-sell agreement is generally not recommended. Normally, group life insurance premiums are tax deductible to the company. But premiums are no longer deductible if the business is the beneficiary.