What are the advantages of a life insurance-funded buy-sell agreement?

There are generally four different means of funding a buy-sell agreement: cash, installment payments, borrowing and life insurance. Most people consider life insurance the best option of all. In order to make a well informed decision, however, you need to have a basic knowledge of what a buy-sell is.

What is a buy-sell agreement?

A buy sell agreement is a legal arrangement whose provisions define the conditions under which a business interest is sold upon certain events. The buy-sell conditions specify the price which the business interest is to be sold at, and restrict the right to the business interest to certain designated parties.

Usually, a buy sell contract is set in action by the triggering of any of the following events: death, retirement, disability, withdrawal from the business at an early stage, and sometimes in a divorce.

Advantages of Using Life Insurance in a Buy-Sell Agreement

Life insurance is the preferred way of funding buy-sell agreements, for the reasons listed below:

• Life insurance is the only funding option which guarantees that money, i.e. death proceeds, will be paid in the event of death.
• Life insurance funding is relatively cheap, compared to other funding options, along with being comprehensible and easy to carry out, without having any negative impact on the business or the capital.
• The life insurance face value is paid in due course after the insured dies, thus facilitating the sale closing process.
• Survivors of the deceased are guaranteed an adequate and fair distribution of business capital and income.
• Survivors of the deceased are not left financially dependent on the business the deceased had been shareholder in.

Bear in mind, however, that you need to consider the other side of the coin, too. There are certain downside costs of funding a buy-sell agreement with life insurance. The requirement that premiums are paid with after-tax dollars and the problem arising out of some shareholders' uninsurability are significant drawbacks.

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