As an owner or co-owner of a business, you've spent years building a valuable financial interest in your company. But what happens if you pass away unexpectedly? Or if you simply want to retire? Without a business continuation plan, all your hard work could vanish in an instant. The easiest way to ensure a smooth transition to the next owner is with a buy-sell agreement funded by life insurance. If you pass away before you retire, your insurer pays a death benefit that that your business partner(s) then give to your family, in payment for the full value of your ownership in the business. It's the cleanest, easiest way to handle the transition when more than one person has a share in a business.
Funding with Life Insurance
Here's how it all works. First, you and your business partner(s) need to take out new life insurance policies on each other. These can be owned by the company, if you like. The important point is that each co-owner holds a policy on each of the other co-owners. Then, if you were to die, for example, your partner(s) or co-owner(s) receive the death benefits from the policies on your life. That money is paid to your surviving family members in return for your share of the business. This solution helps everyone. Your family gets money they can use to help sustain them after your death, and your company stays in the hands of your capable co-owners.
Advantages of Using Life Insurance
As with any business continuation strategy, there are pros and cons you have to consider. In my opinion, the advantages far outweight the disadvantages. They are:
- Life insurance creates a lump sum of cash to fund the buy-sell agreement at death.
- Life insurance proceeds are usually paid quickly after your death, ensuring that the buy-sell transaction can be settled quickly.
- Life insurance proceeds are generally income tax free; a C corporation may be subject to the alternative minimum tax (AMT).
- If sufficient cash values have built up within the policies, the funds can be accessed to purchase your business interest following your retirement or disability.
Disadvantages of Using Life Insurance
- Life insurance premiums are paid with after-tax dollars because the premiums are generally not a tax-deductible expense.
- Premium requirements are an ongoing expense.
- One or more co-owners may be uninsurable due to age or illness.
- If the co-owners' ages vary widely, younger co-owners will have to pay higher premiums on the lives of the older co-owners.
- If the ownership percentages vary widely, more insurance will be needed to cover the owners with the larger ownership interests, resulting in higher premium costs for those with smaller ownership interests.
Most of the time, the advantages of funding with life insurance far outweigh the disadvantages. Without life insurance, what might happen to your business?