Being Creative
Developing a business continuation plan is an important step to making sure a client’s business stays intact at retirement, death or other triggering event. Whether or not you leave the company by choice or by chance, you can attempt to exit the business on track and provide for your family’s future. By arranging a buy-sell agreement using life insurance, you’ll be able to protect yourself, the business shareholders, and your family.
When a buy-sell arrangement is funded with life insurance, the policy owner (normally a co-owner of the business or the business itself) makes use of the coverage proceeds to buy out the business interest of another owner who retires, becomes disabled, or dies. Or, if you choose to retire, the cash value of the life insurance policy can be accessed by the use of partial withdrawals and policy loans to offer a down payment to assist in funding the buyout of your share of the business. Cash values could also be accessed by taking loans and withdrawals from the policy. Loans and withdrawals may generate an income tax liability, reduce available cash value and reduce the death benefit or cause the coverage to lapse.
A properly-constructed buy-sell arrangement anticipates how the value of a company might change over time and provides for acceptable adjustments in the amount of the buyout price. The quantity of life insurance could be designed to differ with the buyout value, so you are always properly covered.
Funding Buy-Sell Arrangements
Buy-sell agreements need a funding mechanism to make sure cash is available to carry out the agreement if a triggering event occurs, without inflicting monetary hardship to the parties involved. Even the most carefully drafted buy-sell arrangement could prove ineffective if there are no funds to buy the deceased shareholder’s interest. Several funding methods besides life insurance can be found, but all have disadvantages:
Using funds from present working capital to fund an installment buyout may restrict the corporate’s potential to operate and will be costly as a result of every dollar paid for the business interest is a nondeductible after-tax dollar. As well as, these funds would cease if the business were to fail.
Borrowing funds from a 3rd party will result in the complete quantity paid for the company being a lot greater than the purchase price, with the final cost depending on the rate of interest and length of the loan. As well as, a lender might not be prepared to lend funds to the business at the very time those funds are needed – when an owner dies.
A sinking fund is a viable resolution when a business owner is uninsurable. One concern with this method is that it might take years to build the necessary funds, however the death of the owner or other triggering events may happen at any time. Additionally, a sinking fund is expensive because deposits are made with personal or business after-tax dollars. Earnings on the fund may also be diminished by income taxes.
Using Life Insurance to Fund a Buy-Sell Arrangement
Life insurance coverage is potentially the least costly method of funding a buy-sell agreement which makes the necessary dollar obtainable at the exact time funds are most needed (at the death of an shareholder). Some benefits of funding a buy-sell arrangement with life insurance might include:
Money is instantly accessible to the entity or its surviving partners to purchase the deceased shareholder’s interest. This also potentially generates supplemental income to the deceased partner’s family or could assist pay estate settlement taxes.
Death benefit proceeds from the life insurance policy are generally income tax free (e.g. absent a transfer for value), and if correctly structured, might also be free from estate taxes. It is very important note that the beneficiary could also be subject to state income taxes and the federal alternative minimum tax. For insurance policies issued after August 17, 2006, IRS 101(j) provides that death benefits from an employer-owned life insurance policy are income taxable in excess of premiums paid, unless an exception applies and certain notice and consent requirements are met before the coverage is issued. Please consult your tax or legal advisors for extra information. Moreover, life insurance owned by a C-corporation might subject the company to the alternative minimum tax
No financial strain on the buyer at the time of purchase. Receipt of the death benefit proceeds allows the satisfaction of the obligation under a buy-sell agreement while releasing company cash flow and personal funds for different endeavors.
Cash value accumulations can be utilized as a substantial down payment in the event of other triggering events, equivalent to disability or retirement.
For additional information on protecting yourself it is important to speak with an experienced advisor.
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