Buy-Sell Agreement Life Insurance

You may need to use buy-sell agreement life insurance when deciding who should own your shares in a company after you die, retire, or sell your business. You need to get an agreement in writing, but the company itself and your shares may have a high value. Affordable buy-sell arrangement life insurance might be your best option to fund the transaction, especially if your company has three or more co-owners.

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Natasha McLachlan is a writer who currently lives in Southern California. She is an alumna of California College of the Arts, where she obtained her B.A. in Writing and Literature. Her current work revolves around insurance guides and informational articles. She truly enjoys helping others learn more about everyday, practical matters through her work.

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Laura Walker graduated college with a BS in Criminal Justice with a minor in Political Science. She married her husband and began working in the family insurance business in 2005. She became a licensed agent and wrote P&C business focusing on personal lines insurance for 10 years. Laura serviced existing business and wrote new business. She now uses her insurance background to help educate...

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Reviewed by Laura Walker
Former Licensed Agent

UPDATED: Aug 25, 2021

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The Rundown

  • Buy-sell agreement life insurance might be your most affordable option to fund a buy and sell arrangement
  • If you use life insurance to fund your arrangement, a trusteed cross-purchase buy-sell agreement is a good option for three or more business owners
  • Proceeds from the buy-sell life insurance policy are generally tax-free, but payments on the policy are not tax deductible

If you are a business owner, you should think about using buy-sell agreement life insurance.

One reason you might be looking at a buy-sell agreement is to make sure that your surviving family is financially stable. Another reason is that you wish to guarantee that the process of selling your business is as smooth as possible.

Now, it may be hard to fund such an agreement. You need to consider how much your business is worth and how much it would cost for anyone to buy out your shares. That’s why using life insurance may be your best option.

Before you begin, you need to compare buy-sell agreement life insurance rates and consider which companies are willing to fund such an agreement. If  you want to look at life insurance quotes from top companies in your area right now, just enter your ZIP code in the free quote tool above.

What is a buy-sell agreement?

A buy-sell agreement (or buy and sell agreement) is a contract that governs who will receive one person’s share of a business after they die, retire, or otherwise leave the company. The person in question can be a sole proprietor, a business partner, co-owner, or private shareholder.

The Legal Information Institute refers to this as a buyout agreement. This agreement is also called a buy and sell agreement, a buy and sell arrangement, a business will, or a business prenup. It helps to establish the value of the business and the value of each person’s share in it.

A buy-sell agreement is preferable for surviving business co-owners who do not want to fight over the direction of a business with a deceased co-owner’s beneficiary.

On the flip side, it may help the beneficiary as well, provided they do not want to have any dealings in the day-to-day operation of the business.

Ultimately, it is best to have a lawyer prepare this agreement.

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How does a buy-sell agreement work?

In most cases, the remaining partners or the company will buy the departing partner/owner/shareholder’s shares, per the contract’s stipulations. There are generally three types of buy and sell arrangements:

  • Entity purchase: This is when the company itself buys the interest of the departing partner or co-owner. If the partner retires, is unable to work, or leaves, they are obligated to sell their shares. A deceased partner’s estate is obligated to sell as well.
  • Cross-purchase: This is when the company’s partners or co-owners buy the interest of the departing partner/co-owner and that person’s estate must sell that person’s shares to the remaining members.
  • Wait and see: Under this agreement, the surviving co-owners of a business may decide whether they will buy the deceased co-owner’s shares or whether the company will do so later. Either way, the deceased’s estate or beneficiaries are compelled to sell the shares.

With a sole proprietor, a key employee may need to buy the shares of the deceased business owner.

Also, an important part of this business arrangement is its funding. Co-owners may want to save funds to buy out shares when the time comes, but that might not be feasible in some cases. Thus, some may decide to use life insurance.

What is a buy-sell agreement life insurance policy?

Buy-sell agreement life insurance may be the most affordable option for funding buy and sell arrangements. When business owners opt to use life insurance to fund a buy-sell agreement, one of two things happens:

  1. Each business partner takes out life insurance policies on the other members (but not on themselves).
  2. The business holds life insurance policies on all the partners.

In either case, each holder of a life insurance policy is its beneficiary. Yes, a business can be a beneficiary.

Ideally, each life insurance policy should produce enough funds to buy out a departing partner or co-owner’s share in the business. However, if the partners can only afford life insurance policies that partly fund the buyout, that can be helpful as well.

If you’re considering using buy-sell life insurance, it’s important to know what type of buy and sell arrangement is best for your situation. Let’s look at how life insurance is utilized under each type of agreement.

Entity Purchase Buy-Sell Agreement

Under this type of arrangement, the company itself buys life insurance policies on the lives of all the co-owners. The company is responsible for paying rates on the policies and it will be the beneficiary of each policy.

Cross-Purchase Buy-Sell Agreement

With this type of arrangement, each co-owner of the business buys separate life insurance policies on the other co-owners. Each co-owner must pay yearly rates for the policies they own, and they are the beneficiaries of the policies they hold.

However, things can get complicated when three or more owners are involved in this arrangement. In such a case, it is better to have a trusteed cross-purchase buy-sell agreement.

When the owners of the business opt for a trusteed cross-purchase arrangement, they will transfer all their shares of the company to a trustee, who then purchases one life insurance policy on each owner. The trust owns the policies and is the beneficiary.

When one owner dies, the trust will receive a payment from the insurance company, pay the deceased partner’s estate, then distribute that person’s shares to the surviving partners.

Wait and See Agreement

This is a hybrid method of funding the buy-sell agreement because the company can purchase life insurance policies on all the co-owners and co-owners can purchase policies on each other.

What is the advantage of purchasing life insurance in a buy-sell arrangement?

There are several advantages for using life insurance to pay for a buy-sell arrangement. However, most stem from the key advantage of producing a lump sum of cash for your co-owners, survivors, and beneficiaries. For example:

  • If the life insurance policy on your life can easily fund your agreement and accrue value, it can also create a lump sum of cash for your family upon your death.
  • Alternatively, the company or remaining business partners can use the funds to purchase your shares after you leave the business.
  • The life insurance policy’s proceeds are usually dispersed quickly, and that ensures the quick sale of your business or business shares.

Additionally, each life insurance policy’s proceeds are usually tax free. Now, if your business is a C-corporation, it will be responsible for paying the alternative minimum tax (AMT).

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Are there any disadvantages to purchasing life insurance in a buy-sell arrangement?

These are the disadvantages of using life insurance to fund a buy-sell agreement:

  • Life insurance payments are not tax-deductible.
  • You must make yearly payments on the insurance policies you hold, so that is an added expense.
  • Co-owners with smaller shares will have to pay higher insurance rates on the lives of co-owners with larger shares.

Additionally, one or more partners in the business may not be insurable based on their age or health history. Younger co-owners may have to pay higher buy-sell agreement life insurance rates on the lives of older co-owners if their ages vary widely.

You can mitigate some of these problems by having a trusteed cross-purchase buy-sell agreement. Under such an agreement, all partners may decide to pay the same amount each year.

Why You Might Want to Buy Buy-Sell Agreement Life Insurance

Buy-sell agreement life insurance might be right for you if:

  • Each life insurance policy can cover each partner’s share in the business.
  • Life insurance is a cheaper option for you to fund your buy-sell agreement.
  • You want the peace of mind that life insurance gives you since it is the most reliable source of funding.

Again, if affordable buy-sell life agreement insurance only funds part of the agreement, you might still consider this option because every little bit can help. You will just need to diversify your funding sources.

Ultimately, you need to find an insurance company that will fund your agreement. Make sure to compare buy-sell agreement life insurance quotes. For example, The Hartford, Lincoln Financial Group, and State Farm may each act as a buy-sell agreement life insurance company.

Hopefully, you have learned something about buy-sell agreement life insurance and why it may be an option for you. To look at life insurance rates from the top companies in your area, enter your ZIP code into our free quote tool below.

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