8 Advantages of Buy-Sell Agreements

There are a number of advantages to using a buy-sell agreement. Understanding them will make a major difference in the choices made regarding policies. This article provides an overview of the top 8, and they include:

1. Life insurance funding has a relatively low cost, is simple to explain and implement, and will not adversely affect the working capital or credit position of the business.
2. Life insurance is the only means of guaranteeing that death—one event that creates the need for cash—also creates the cash to satisfy that need.
3. Survivors of the deceased shareholder are freed from financial dependence on a business that has just lost a key individual.
4. Survivors of the deceased shareholder are assured of a fair (and hopefully sufficient) amount of both capital and income.
5. The insurance proceeds are paid quickly after the insured’s death, making it easy to close the sale quickly.
6. If a cash value life insurance policy is used, the cash value can be used as a tax-deferred sinking fund for a lifetime buy-out, which is generally more likely to occur than a buy-out at death. Keep in mind that if the owners were planning on using term insurance to fund the buy-out at death, they are already paying the mortality cost, so the additional premium needed for a cash value policy generally goes towards building cash value.
7. If the life insurance policy has a chronic illness rider, the death benefit can be accelerated and used to buy-out a chronically ill owner.
8. If life insurance is used to fund an entity purchase arrangement for a partnership, Limited Liability Company (LLC), or S corporation, upon the death of an insured owner the receipt of the tax-free death proceeds causes a basis increase (the lack of a basis increase is generally a major disadvantage of an entity purchase arrangement). It is possible to have the entire basis increase allocated solely to the remaining owners–with S corporations this is accomplished by making an election to terminate the tax year and causing the death proceeds to be received in the next tax year; with partnerships and LLCs this is accomplished by including a provision in the operating agreement allocated the basis to the surviving owners.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM