What would occur within your company in the event of the unforeseen passing of one of the owners, whether they are Corporate Officers or Partners? Have you established a prepared strategy that ensures the seamless continuation of the company, or would the company be forced into a disruptive situation where it needs to liquidate assets to compensate the heirs? Alternatively, would the heirs be integrated into the company as new part-owners?
A chief concern among business owners is what will 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 that their family is financially secure and compensated fairly in case something happens to them.
There needs to be a plan in place. Like most good plans it needs to answer the 6 basic questions: “Who?”, “What?”, “Why?”, “When?”, “Where?” & “How?”
- Who: All the owners
- What: Buy/Sell Agreement
- Why: To keep chaos at bay
- When: Now
- Where: Here
- How: “Succession Plan Plus” Life Insurance
A buy-sell agreement can address all these concerns. It is 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 deceased’s interest in the company according to the agreed-upon terms of the contract. In addition, the deceased’s heirs are required to comply by selling their inherited interest at the previously agreed-upon price.
A Buy-Sell Agreement is a document used when a company wishes to make an agreement with the owners of the company on how their interest in the company, called “Ownership Units,” may be sold or transferred. A comprehensive Buy-Sell Agreement will also address what happens if one of the owners dies. These documents govern what happens in various situations, including if an owner wants to voluntarily sell their ownership in the company during their lifetime. The company can be of various forms – a corporation, LLC, partnership, etc. – the same types of questions will be asked.
Types of buy-sell life insurance include the following:
Cross-Purchase Plans: Under this type of plan, the owners enter into an agreement with each other (usually prevalent in partnerships). 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 owner receives life insurance proceeds income-tax-free and uses said proceeds to purchase the deceased’s business interests, while the heirs receive an agreed-upon payment for their business interest.
Entity Plans: In this type of agreement, also known as a stock redemption plan, the company purchases life insurance policies for each owner (most prevalent in corporations and LLCs), 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 deceased’s business interest, while the heirs receive an agreed-upon payment for their business interest.
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 either to save money now and pay cash or to take out a loan to buy out a deceased owner’s share in the company. Both situations can be financially risky, both for the surviving owner(s) and the company itself.
The smartest method for funding a buy-sell agreement is through life insurance. This ensures that 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 deceased’s share are purchased for pennies on the dollar and the premiums will likely be significantly lower than the cost of repaying loan interest.
There is more than just one type of policy that will address an owner’s death. The most basic and least expensive plan is the use of term policies. However, if the owners outlive the policies, then their premiums are gone as well as the policies. It’s crucial to understand a key statistic: a staggering 99% of term policies ultimately do not result in claim payouts. This is primarily attributed to policy lapses by individuals or the natural expiration of the policy term itself. You can verify this statistic from sources such as Penn State University and Consumer Reports.
The most beneficial is the “Succession Plan Plus” policy.
The Succession Plan Plus is a uniquely designed IUL (Indexed Universal Life) Life Insurance policy for each of the owners that:
- Pays the company a predetermined death benefit upon the demise of a principal. The policy can be designed in such a way that the death benefit increases every year, while the premium remains level.
- So that the heirs can be paid without devastating the company
- Prevents business disruption.
- Ensures the continuity of business ownership and operational stability.
- Assures funding sources of the company’s ability and desire to continue operations should the unthinkable happen.
- Is a cash value policy that grows in value, beyond the premiums paid, with continuous growth…..
- Uninterrupted Compounding. (Borrowed funds do not diminish the cash value.)
- Ride the Bull Market up (no cap). (Has earned as much as 23% in a single year.)
- Bear Market protection (guaranteed minimum gain of .25% annually)
- Receptacle for low interest-bearing cash.
- Is a borrowing policy that enables the company.
- To borrow up to the cumulative cash value of the policies at a variable rate, not to exceed 5%
- To borrow without qualifying. Your cash value is the only governor as to how much you can borrow.
- To decide how and when to pay-back..
- Protects your money (cash value) from:
- Gains being taxed
- Creditor Demands
- Lawsuits
- Judgments
- Liens
- Creates tax-free retirement income for each of the remaining owners.
- The savings component can grow at a substantial rate if the policies are designed correctly.
- Your withdrawals are tax-free and sanctioned by the IRS.
The “Succession Plan” primarily refers to “1” above. The “Plus” refers to “2-5” above.