Using Life Insurance to Buy a Deceased Owner's Business Interests

Buy-Sell Agreements frequently mandate that the business entity itself, or the individual owners of the business, purchase the business interests of an owner who dies. This requirement provides the deceased owner’s family with some financial support while also enabling the surviving owners to control who their co-owners are.

Of course, purchase requirements only work when there is money available to pay for the purchase. When the event triggering a purchase is due to the death or permanent disability of an owner, the money often comes from life insurance.

Having an outside source of cash to pay the purchase price is important because businesses typically are not cash-rich themselves, and the business likely was a chief source of income for the deceased owner during his or her lifetime. Therefore, the loss of that income can be devastating to the deceased owner’s family.

If there are more than two owners of the business, if ownership interests are not equal and/or if the owners are of varying ages and insurability, it may be best to have the entity own the life insurance policies and redeem the deceased owner’s business interests.  Life insurance gets more complicated if the plan is to have the individual owners buy out the deceased owner’s interests in the business.  That’s because each owner would then need to own a life insurance policy on every other owner, which results in significantly more policies.

Moreover, the expenses incurred by each owner to purchase life insurance on the other owners will differ because the premiums are based on the cost of insuring the other owners and are usually age and health-related. And if one of the owners fails to pay on time the premiums on his or her set of life insurance policies, those policies will lapse. The result may be that insufficient funds are available for the purchase of the deceased owner’s business interests.

Whole life insurance has certain advantages over term insurance because premiums for term insurance rise with the age of the insured whereas whole life insurance premiums are flat, and whole life can’t be cancelled by the insurance company as long as the payments are timely made. On the other hand, premiums for whole life insurance – while flat – tend to be higher, particularly in the early years of the policy. On the other hand, the business may get a better return on the money used to pay the higher whole life premium by investing it in their business.

Regardless of which type of life insurance policy is used, as the business grows in value, additional life insurance may need to be acquired to cover the purchase of the business interests of owners when they die.

Sometimes business owners set up a separate entity to own the life insurance for the fulfillment of the Buy-Sell Agreement because there can be some cost and/or tax advantages in doing so.

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Disclaimer: This Blog is for informational purposes only and is not to be construed as legal advice. If you have questions, please seek the advice of an attorney. An attorney-client relationship is not formed by reading this Blog. If you are interested in Wittenburg Law’s representation of you, you must contact Wittenburg Law for a determination of whether your matter is one for which Wittenburg Law is willing and able to accept representation of you.

Bonnie Wittenburg, Wittenburg Law Office, PLLC, 601 Carlson Parkway, Suite 1050, Minnetonka, MN 55305         952-649-9771     bonnie@bwittenburglaw.com   www.bwittenburglaw.com