Avoid Crazy Aunt Martha With Buy-Sell Agreements
A chief concern among business owners is what'll happen upon the death of one of the owners and how will it affect the business, the other owners and the heirs of the deceased owner? Surviving owners want to ensure the continuity of ownership and not risk having a large share of ownership fall into the hands of potentially inexperienced heirs of the deceased. In addition, they want to protect themselves and the company financially. On a personal level, owners want to also ensure their family is financially secure and compensated fairly in case something happens to them.
A buy-sell agreement can address all of these concerns. It's a contract among business owners which, upon the death of one of the owners, requires the remaining owners or the company itself to purchase the deceaseds interest according to the agreed upon terms of the contract. In addition, the deceaseds heirs are required to comply by selling their inherited interest at the previously agreed upon price.
Funding a Buy-Sell Agreement
There are various options for funding a buy-sell agreement, but some carry more risks than others. Some owners choose to open a company savings account now to pay cash should the death of an owner occur. The main problem with this strategy is the uncertainty of the future: what if a catastrophe happens next week, or even next year? Relying on such a savings account presupposes that nothing will happen to the owners for many years while money accumulates in the account. Another option, also carrying many risks, is to wait and simply take out a loan should something happen to one of the owners. This can create unnecessary financial risks for both the surviving owner and the company itself.
The smartest method for funding a buy-sell agreement is through life insurance. This makes certain funds are immediately available when a death occurs; plus, death benefit proceeds are generally income-tax free. In addition, the funds used to buy the deceaseds share are purchased for pennies on the dollar and the premiums will likely be significantly lower than the cost of repaying loan interest.
Types of Buy-Sell Life Insurance Plans
Cross Purchase Plans
Under this type of plan, the owners enter into an agreement withone another. Each owner purchases a life insurance policy on the other owners and will be named the beneficiary of the policy. Upon the death of an owner, each surviving one receives life insurance proceeds income-tax free, heirs receive an agreed-upon payment for their business interest and the surviving owner(s) use the proceeds from the life insurance policy to redeem the deceased owners interest in the company.
In this type of agreement, also known as a stock redemption plan, the company purchases life insurance policies on each owner, with the company itself as the beneficiary. When an owner dies, the company receives the life insurance proceeds and uses said proceeds to purchase the deceaseds business interest, while the heirs receive an agreed-upon payment for their business interest.
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