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You make plans for your assets when you die. Would your family have any idea what to do with your business? Would they know how to sell it?
It’s likely they would not. That’s why life insurance buy sell agreements are so important. The buy-sell agreement allows your beneficiaries to receive their portion of funds from the business without the need to deal with the business itself. The agreement outlines how each share of the business will be sold to the company or other owners.
Buy sell agreements can be used in other scenarios other than death. They can also go into effect if an owner retires or doesn’t want the company anymore. When buy sell agreements are funded with life insurance, a life insurance policy is purchased on the co-owner. In the event of their death, the transition is made much smoother by providing the funds for the buy-sell agreement.
Essentially, you’re combining life insurance with a buy-sell agreement. Either a co-owner or the company itself buys life insurance policies on each of the co-owners. When one of the co-owners dies, the death benefit can be used to buy their part of the company.
As a result, the family of the deceased co-owner can obtain cash instead of a portion of the business in which they have not been involved. The business is taken over by people who know exactly how to run it and the company carries on smoothly.
Just like with any life insurance policy, premiums are an ongoing expense. If a company has many owners you are buying policies for, the premiums will vary. For example, younger owners may have to pay higher premiums on the older owners. Some owners may not be insurable at all due to their age or illness.
If the percentage each person owns varies, the amount of death benefit needed to buy their portion will vary. This also affects the premiums paid.
There are two options when setting up a life insurance buy sell agreement.
A cross purchase agreement: This is where each business owner buys a life insurance policy on each of the other owners. When an owner dies, the remaining owners use the death benefit to buy that owner’s part of the business.
An entity agreement: Each owner is a part of an agreement with the company to sell their share of the business. In this case, the company itself is buying the life insurance policies on each of the owners. The company pays the premiums. When one of the owners dies, the company can use the death benefit to buy the share of the business from the family or estate.
Depending on how much of the company a person owns, you can calculate how much you’ll need to buy that portion from their family. This is how you determine how much life insurance to purchase.
This can get complicated if what the business is worth changes after the policies are in force. It’s important to include how you’ll handle these differences in the buy sell agreement.
On the other hand, the value of your portion of the business may decrease after the policies are in force. This also needs to be addressed in the agreement. Will the funds go to the family, the business, or the surviving co-owners?
When a policy is in force for years, cash value starts to build up in the policy. The longer premiums get paid the more cash value the policy has.
If one of the owners retire or is diagnosed with a disability they may be looking to sell their part in the business. In these situations, you can look into accessing the life insurance funds to purchase the business share.
Life insurance buy sell agreements can be used in situations outside of death. You can sell these life insurance policies in a life settlement before the owner dies. That way the business or co-owners have the funds to buy the portion of the business from the retired/disabled owner.
If you are considering selling a life insurance policy, start with a life settlement calculator. This will give you a good idea of what the policy may be worth. There are a lot of factors that go into whether a policy qualifies for a life settlement. As well as how much your policy is worth.
A free consultation with Windsor will help you get a clear view of your options so you can make the best financial plan for yourself.
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