Life Insurance for Businesses

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LIFE INSURANCE FOR YOUR BUSINESS

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BUT WHAT HAPPENS WHEN ONE OF THE PARTNERS DIES?

Building a successful business can be one of life’s most satisfying experiences. You’ve created an asset for your family while providing income for your employees to provide for their families.

buy-sell

How a Buy-Sell Life Insurance Agreement is used by Businesses

A buy-sell agreement is designed to protect a business, the owners and their heirs if one of the owners were to die unexpectedly. Basically, this agreement protects the fundamental continuity of the business for the remaining owner(s) by buying out the deceased owner’s share from their heirs.

This is done by each owner of the corporation purchasing a life insurance policy on the other shareholders or owners of the company.

Cross Purchase Buy-Sell Agreement Life Insurance

One version, called a “cross-purchase buy-sell agreement” is the most popular buy-sell life insurance structure for a small corporation with no more than four owners.

Reason being, a cross-purchase agreement requires each owner to buy an individual policy on each of their partners. The amount of life insurance is equal to their respective share of the net worth of the business. A corporation with just four owners would need a total of 12 life insurance policies, each owner would buy a policy on the other three partners (3 x 4 = 12).

Each owner will be beneficiary, payor, and owner of each policy they purchase on the lives of the other business owners. It provides a clear outline of how the deceased owner’s heirs will sell their interest to the remaining owner(s) with the insurance proceeds. One of the benefits of this type of buy/sell agreement, is the family of the deceased owner’s tax basis will be equal to the fair market value at time date of death, making for favorable tax treatment on the death proceeds.

Stock Redemption Plan

A stock redemption plan is another popular option worth considering. This agreement is ideal for a closely held corporation with more than a few shareholders.

The shareholders of the corporation enforce limitations on the transferability of stock held by each party of the agreement. In a stock redemption plan, the business purchases individual life insurance policies on each of the owners.

When a shareholder suddenly dies, the corporation buys the deceased owner’s share from their heirs with the life insurance proceeds (at a previously agreed upon price). The deceased owner’s heirs receive immediate liquidity at fair market value for their business interest. The two distinct benefits of stock redemption plans over cross-purchase agreements are:

1. Stock redemption plans are easier to manage when there are multiple partners since only one policy per owner is needed.

2. The corporation bears the inequality of life insurance premiums due to varying owner’s gender, age, health, lifestyle etc…

The business pays the premiums, is the policy owner, and is the beneficiary on each of the policies in a stock redemption plan.

It’s important to note that stock redemption plans are more at risk to estate taxes due to IRS traditionally questioning the undervaluation of the stock by the closely held corporation.

The most apparent disadvantage of stock redemption plan is the remaining owners don’t get the benefit of a step-up in basis when the corporation purchases the deceased owner’s interest.

Basically, this translates to stock redemption plans being more vulnerable to higher capital gains taxes than cross-purchase agreements if their share is sold prior to their death. Therefore, estate tax consequences should be discussed with your tax professional before executing a stock redemption plan to protect your business.

Agreement Structure and Taxation

Buy-Sell agreement structure and taxation considerations vary state to state. You will generally utilize the rules of the state where your business owners reside. Advise us if your business reside in different states.

How to Handle the Policy Cost

How do businesses handle the insurance cost inequality? There may an unfair disparity with premiums due to each owner’s age and health. A young owner may be responsible to pay hefty premiums for an older owner with current or previous health complications.

Determining How Much Coverage to Obtain

When setting up a buy-sell agreement for your business, how much coverage should you buy on each owner? The amount of coverage purchased on each business owner is determined by the owner’s share of the business, and the overall value of the business itself.
When determining the value of a business, there are 3 common methods that life insurance companies will accept when approving your policies.

1. Book Value : The book value of a business is calculated just like the net worth of an individual. With this method, add up the sum of the liabilities or debt that the business has, and subtract this amount from the assets the business owns.

The book value of your business is determined by financial accounting and is generally the better choice for businesses with a lot of fixed assets like land, buildings, and equipment.

Additional Uses for Business Life Insurance

In addition to Buy-Sell agreements, businesses use life insurance for additional purposes.

  • Insuring a Key Employee
  • Employee Retention
  • Group Life Plans

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