For business owners and private shareholders, a buy-sell agreement may be a critical part of long-term planning. It could help facilitate a smooth transfer of ownership in the event of a partner’s death, while also providing potential financial protection for the deceased’s family. One method that might be used to fund a buy-sell agreement is life insurance. When structured appropriately, life insurance could offer a source of liquidity that may allow surviving owners or the business itself to purchase the deceased owner’s share.

At Mirus Financial Partners, we work closely with clients to explore funding strategies—including the potential role of life insurance—in a way that aligns with each client’s goals, structure, and long-term vision.

How Life Insurance Might Be Used

Life insurance may be used to fund a buy-sell agreement by having the company or co-owners purchase policies on one another’s lives (excluding their own). If an owner were to pass away, the death benefit from the policy might be used to buy out the deceased owner’s business interest. In such cases, the arrangement could help ensure that the surviving owners retain control of the business, while the deceased’s family or estate might receive financial compensation for the owner’s share.

Possible Advantages of Using Life Insurance

• May provide a lump sum of funds to support a buyout at death
• Proceeds could be paid relatively quickly, helping to expedite the transaction
• Under current tax law, death benefits might be received income-tax-free (subject to exceptions)
• If policies accumulate cash value, they may potentially be used for other purposes, such as retirement or disability buyouts

Potential Challenges to Consider

• Premiums are generally not tax-deductible and may be paid with after-tax dollars
• Payments could represent a long-term financial obligation
• One or more owners may be uninsurable due to health or age
• Significant age or ownership disparities might create premium imbalances
• The cost to insure majority owners could fall disproportionately on minority owners in cross-purchase agreements

These are among the reasons why business owners might consider working with a financial advisor who provides individualized attention and ongoing monitoring.

Different Structures to Explore

The structure of a buy-sell agreement may influence how life insurance is used:

Entity Purchase Agreement
In this arrangement, the business may purchase policies on each owner and use the proceeds to buy the decedent’s interest. The business is typically the policy owner, premium payer, and beneficiary.

Cross Purchase Agreement
Each owner might purchase a policy on every other owner. In the event of death, surviving owners could use the proceeds to buy out the deceased’s share. While this can work well for smaller ownership groups, it might become complex as the number of owners increases.

Wait-and-See (Hybrid) Agreement
This structure could provide flexibility, allowing the business or the surviving owners to determine at the time of death who will complete the purchase. It may combine elements of both entity and cross-purchase strategies.

The advisors at Mirus Financial Partners help businesses assess which structure may be most appropriate for their circumstances.

The Importance of Full or Partial Funding

Ideally, the insurance coverage might equal the estimated value of the owner’s business interest. However, if full funding isn’t immediately possible, partial coverage may still be better than none. Over time, the amount of coverage could be increased, or additional funding methods may be added. The agreement itself should include provisions for how to handle any gaps in funding.

Accounting for Changes in Business Value

Business valuations may change over time. If the business grows significantly, the insurance proceeds might not fully reflect the increased value of an owner’s interest. Conversely, if the value decreases, the death benefit might exceed the business interest. In either case, the agreement could outline how to handle any shortfalls or surpluses, potentially avoiding disputes among heirs, co-owners, or the business.

Group Life Insurance Considerations

Although a company may offer group life insurance to employees, it generally might not be an ideal method to fund a buy-sell agreement. Tax treatment could be less favorable if the business is both the owner and beneficiary of the policy.

Potential Tax Implications

Several tax considerations might arise when using life insurance in this way:

• For policies issued after August 16, 2006, death benefits payable to the employer could be taxable unless certain notice and consent requirements are met
• In a cross-purchase agreement, transferring policies between owners might trigger a “transfer-for-value” scenario, potentially resulting in taxable proceeds
• Surrendering a policy for its cash value may generate taxable gain, including any outstanding policy loans
• In a C corporation, policy proceeds might be subject to the alternative minimum tax (AMT), depending on the circumstances

Given these possibilities, it may be wise for business owners to work with a financial professional who understands the tax and legal nuances involved.

Ongoing Maintenance and Monitoring

Buy-sell agreements funded by life insurance require consistent upkeep. Premium payments must be made on time, and coverage should be reviewed regularly to ensure it reflects the business’s current value. If increasing coverage isn’t feasible, the business may want to consider alternate or supplemental funding methods. Additionally, evaluating the financial strength of the insurance carrier may help ensure long-term policy reliability.

Mirus Financial Partners provides personalized, ongoing support to help clients keep their agreements up to date—because even the best-drafted buy-sell plan could fail without proper funding and oversight.

Why Personalized Advice Matters

There’s no one-size-fits-all solution for funding a buy-sell agreement. The right strategy may vary based on the size of the business, number of owners, financial goals, and succession plans. That’s why Mirus Financial Partners takes a personalized approach—offering tailored financial planning services designed around each client’s unique situation.

If you’d like to explore what might work best for your business, let’s start a conversation about building a strategy that fits your goals. Contact Mark Vergenes today.