There are disadvantages and costs to using a life insurance-funded buy-sell agreement. Understanding them will make a major difference in the choices made regarding policies. This article will explain the top three disadvantages, which include:
- Premiums must be paid with after-tax dollars.
- Uninsurable shareholders present a problem. Planners should note, however, that very few individuals are refused insurance because of age or physical health. Most insurers will agree to cover almost any age (up to the mid-seventies) and will insure illnesses by adding a rating, which is a charge that equates the total premium to the appropriate level of additional risk the insurer is assuming.
- With a stock redemption plan, the corporation needs only one policy on each shareholder’s life. But in the case of a cross-purchase plan, especially one that involves more than three shareholders, where each shareholder owns a policy on each other shareholder’s life, the number of policies (and therefore the administrative complexity, cost, and potential for error) multiplies each time new insurance is added because of an increase in the valuation of a stock interest.
To ascertain the number of policies needed where a cross-purchase agreement is used, multiply the number of shareholders by that same number less one. In other words, the formula for determining the number of policies is N × (N – 1) with N being the number of shareholders. So if there were four shareholders, twelve new policies would be needed each time the business interest was revalued.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM