How to use insurance in business succession plans
As a business owner, you've poured your heart and soul into your work. It's only right that you'd want to protect everything that you've built. That's why it's smart to think ahead about how your business will carry on when you retire, should you decide to sell it, or in the event of your death. It might not be the easiest topic to think about, but life insurance can make business succession planning a lot easier and help give you confidence to face the future.
If an owner passes away, the death benefit from a life insurance policy can provide beneficiaries with a lump sum of cash that can be used to buy out the deceased owner’s share of the business right away — making the transition smoother for everyone involved.1
There are several business succession planning strategies, but business continuation is often implemented through the use of a “buy-sell agreement.” This is when one party (or sometimes multiple parties) agrees to buy the deceased owner’s share of the business at a predetermined price from the deceased owner’s estate or heirs. There are two common approaches to structuring a buy-sell agreement: The first is cross-purchase, where the remaining owners or partner purchase a share of the business, and the second is entity-purchase, where the business itself buys the deceased owner’s share.2 Before using an entity purchase, consult with your legal and tax advisors to ensure your succession plan does not create future tax issues. This has become more important following the Supreme Court's decision in the case of Connelly v. Unites States. That decision determined that proceeds from a life insurance policy owned by a closely-held corporation and used to redeem a deceased shareholder's stock are part of the corporation's value for federal estate tax purposes.
A life insurance policy can help provide the funds necessary for the buy-sell agreement. Together, the buy-sell agreement and life insurance policy can help smooth the transition in ownership, meaning there’s less potential disruption in the day-to-day running of the business. Life insurance can be one of the most useful funding methods for the buy-sell agreement, since it’s common for the surviving owner or the business to lack the cash to pay the deceased owner’s estate.
Without these components, any other owners of the business may have to liquidate if the deceased owner’s heirs aren’t interested in keeping the business. The remaining owner(s) might try to raise the capital needed to buy out the heirs — but if they can’t, that could be the end of the business. Planning can make a world of difference in keeping the business on track.
A buy-sell agreement should outline when an owner can or must leave, these are called the triggering events, and can include things like death or permanent disability as well as an owner filing for bankruptcy or getting divorced.3 The agreement should also detail who can buy the departing owner’s share of the business, how much the departing owner’s share of the business is worth, and what happens to the business after the owner leaves. If life insurance proceeds will be used to purchase a deceased owner’s company share, this needs to be included in the buy-sell agreement.4
One of the main types of life insurance you can use to fund a buy-sell agreement is whole life insurance. It can be kept in force for the life of the person who’s insured if the required premiums are paid. Whole life insurance offers guarantees regarding the premiums, the cash value, and the death benefit. Many whole life policies also guarantee a level premium at the outset. Assuming the premiums are paid in full and on time, the cash value of a whole life policy is designed to grow at a guaranteed pace as stated in the contract.5 The death benefit is also guaranteed, so long as premiums are paid as scheduled.
Some whole life policies also pay dividends (when issued by a mutual insurance company) and are considered participating policies.6 When the insurance company pays dividends to its whole life policies, the cash value and the death benefit both have the potential to increase.
As a business owner, you already have a lot on your plate. But planning for your business’s future isn’t something to overlook. I can help you set up a succession planning strategy that’s right for you and helps preserve your business’s future.
Disclaimer:
1 Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.
2 Buy-Sell Agreement Definition, Types, Key Considerations, Investopedia, September 24, 2024, https://www.investopedia.com/terms/b/buy-and-sell-agreement.asp
3 Amanda Hayes, Buy-Sell Agreements for Small Business: Basics and Frequently Asked Questions, NOLO, May 18, 2023, https://www.nolo.com/legal-encyclopedia/buy-sell-agreement-faq.html
4 Ibid
5 Some whole life policies do not have cash values in the first two years of the policy and don’t pay a dividend until the policy’s third year. Talk to your financial representative and refer to your individual whole life policy illustration for more information.
6 Dividends are not guaranteed. They are declared annually by Guardian’s board of directors.
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
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