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:
- 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.
- 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.
- Survivors of the deceased shareholder are freed from financial dependence on a business that has just lost a key individual.
- Survivors of the deceased shareholder are assured of a fair (and hopefully sufficient) amount of both capital and income.
- The insurance proceeds are paid quickly after the insured’s death, making it easy to close the sale quickly.
- 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.
- 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.
- 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