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When two or more people establish a business together, there must be provisions made should one of those partners pass away. Many use life insurance for funding buy-sell agreements. These agreements help establish what happens to the company if someone dies.
Legally, if a business partner dies, his or her spouse or beneficiary would inherit his or her share of stocks in the business. For many business professionals, this situation is not acceptable. They need a guarantee that if one business partner dies, the company will not suffer.
While it would be nice if everyone got along following a death, odds are high that the spouse or beneficiary will have his or her own strong ideas on how the business should be handled. Even if things were flowing smoothly, a new partner can wreak havoc during meetings, votes and with day-to-day operations.
Another issue with partnerships is that with one person's death, the money they were investing into the business can be lost forever. Buy-sell agreements can ensure the fiscal health of a business should one partner pass away unexpectedly.
Buy-sell agreements involve a guarantee that if a partner dies, that person's shares are then bought out and split by the remaining partners. One of the ways to do this is buy setting up a specific life insurance policy that covers the value of the shares that is paid for. Each member of a partnership or corporation pays for an insurance policy. If there were three partners in a business and the business if valued at $1.2 million, each partner would purchase $200,000 in life insurance on each of their partners. The deceased's shares of stock are then split evenly between the surviving members.
The money resulting from the transfer of shares then goes to the beneficiary chosen by the deceased. Buy-sell agreements of this type are often favored because the life insurance money is tax-free. There can be problems, however, if the partners change frequently during the life of the business. Each time a new partner is brought in, the life insurance policies would have to be changed.
When a buy-sell agreement is chosen, many items are agreed upon. First, shareholders or business partners will come up with the terms of the agreement. This includes a buyout price, insurance type, terms of the transfer of shares, terms of the payments and events that would lead to the buyout.
Using life insurance to fund a buy-sell agreement is the most logical way to handle terms of a partnership. It's a simple and relatively inexpensive way to guarantee that a person's death does not negatively impact a business.