Fund Your Buy-Sell Agreement with Life Insurance

Yes: Life Insurance Is a Common Way to Fund a Buy-Sell Agreement

Can life insurance be used to fund buy-sell agreements? Yes. A buy-sell agreement sets the terms for an owner’s share to be bought when that owner dies, retires, becomes disabled, or leaves. Life insurance can supply the cash for that purchase when an insured owner dies.

Without funding, the surviving owners or the business must find the money another way. They may use savings, borrow, or pay in installments over several years. Meanwhile, the family of the deceased owner waits for payment.

A funded agreement sets the death benefit to match the buyout price or valuation formula in the agreement. The premium you pay is not the measure. This approach fits co-owners of closely held companies, partnerships, professional practices, and family businesses.

Florida business owners often hold their interests through a corporation, a partnership, or an LLC. The entity type affects how the agreement is written and how the policy is set up.

A common mistake is an agreement with a price but no money behind it. The business value can rise, while the policy amount stays the same.

Three Ways the Policy Can Be Structured

Most funded agreements use one of three structures: cross-purchase, entity redemption, or a hybrid. The right choice depends on the entity type, the number of owners, and the cash flow the owners can support.

Cross-Purchase

Each owner buys and owns a policy on each other owner. When one owner dies, the survivors receive the proceeds and buy that owner’s interest from the estate. The policy count grows fast. Three owners need six policies. Four owners need twelve.

Entity Redemption

The business owns one policy on each owner. When an owner dies, the company collects the death benefit and redeems that owner’s shares. The remaining owners then hold a larger percentage, because the redeemed shares are retired. This route needs fewer policies, but it has its own tax rules.

Hybrid or Trusteed Structures

Some owners combine the two approaches. Others place the policies in a trust that owns them and pays the buyout. Each choice carries different ownership, premium payment, and tax results. The agreement language must match the structure you pick.

What the Policy Must Cover to Fund the Agreement

Under Fla. Stat. § 627.404, an individual party to a contract for the purchase or sale of an interest in any business entity has an insurable interest in the life of each other party to such contract, for the purpose of such contract only. Separately, Fla. Stat. § 627.404 provides that a contract of insurance upon a person, other than a prepaid funeral contract or group life, group or blanket accident, health, or disability insurance, may not be carried out unless, on or before the time of entering into that insurance contract, the person insured, having legal capacity to contract, applies for or consents in writing to the contract and its terms. Its death benefit must match the buyout formula. The coverage type matters because term and whole life serve different periods.

• Insured persons. For each owner whose share may be bought, the other individual parties to the buy-sell agreement hold an insurable interest in that owner’s life for the purpose of the agreement only (Fla. Stat. § 627.404). That owner must also apply for or consent in writing to the policy and its terms on or before the time the insurance contract is entered into (Fla. Stat. § 627.404). Fla. Stat. § 627.404 reads: “(5) A contract of insurance upon a person, other than a policy of prepaid funeral contract; group life insurance; or group or blanket accident, health, or disability insurance, may not be carried out unless, on or before the time of entering into such contract, the person insured, having legal capacity to contract, applies for or consents in writing to the contract and its terms, except that any person having an insurable interest in the life of a minor younger than 15 years of age or any person upon whom a minor younger than 15 years of age is dependent for support and maintenance may obtain a policy of insurance on the minor.” The policy owner and beneficiary must match the chosen structure.
• Death benefit amount. Set the amount to the price the agreement’s valuation method produces. Update it when the business value changes.
• Term life insurance. Term coverage lasts for a set period, such as the years until expected retirement. FINRA’s guide to insurance products explains that term coverage lasts for a limited period.
• Whole life insurance. Whole life provides lifetime coverage and includes a cash-value feature, according to FINRA’s guide to insurance products. The contract and any illustration describe how that cash value works.
• Key person insurance. This is related but separate. It protects the business from losing an owner’s contribution. Buy-sell funding pays for the ownership interest itself.
• Insurability. Health questions are required. Coverage may depend on insurability, and the insurer decides issue and rating from the application.

How the Process Works, Step by Step

The process starts with the agreement and ends with a payment under its terms. Each step should be finished before the next one begins.

1. Review the agreement. Confirm the trigger events, the valuation method, the payment terms, and who must buy. Florida Statutes s. 607.0732 sets formal requirements only for the shareholder agreements it authorizes, which are agreements that may depart from other provisions of chapter 607 on matters such as the board’s powers, voting or deadlocks. Such an agreement must be set forth or referenced in the articles of incorporation or bylaws and approved by all persons who are shareholders at the time of the agreement, or set forth in a written agreement signed by all of those shareholders and made known to the corporation. The section also states that it does not limit or invalidate agreements that are otherwise valid, including shareholder agreements between or among some or all of the shareholders.
2. Match the structure and amount. Choose cross-purchase, entity redemption, or a hybrid. Set each death benefit to the agreed price.
3. Get consent and apply. Under Fla. Stat. § 627.404, a business may insure an owner only with an insurable interest and written consent before the purchase. Each insured then answers health questions. The insured must apply for or consent in writing on or before the time of entering into the contract, so the timing is not left to the insurer’s underwriting. Fla. Stat. § 627.404 reads: “A contract of insurance upon a person, other than a policy of prepaid funeral contract; group life insurance; or group or blanket accident, health, or disability insurance, may not be carried out unless, on or before the time of entering into such contract, the person insured, having legal capacity to contract, applies for or consents in writing to the contract and its terms, except that any person having an insurable interest in the life of a minor younger than 15 years of age or any person upon whom a minor younger than 15 years of age is dependent for support and maintenance may obtain a policy of insurance on the minor.”
4. Issue the policy. Confirm the owner and beneficiary are correct. Update the agreement to reference the funding.
5. Review each year. Revisit the valuation, insured ages, ownership changes, and premium payments at least once a year. Review again after any change in ownership or value.
6. Pay at a trigger event. The death benefit goes to the designated owner or entity. That party completes the buyout under the agreement’s terms.

Tax, Ownership, and Transfer Rules a CPA Reviews

Death benefits generally are excluded from gross income, according to the IRS guidance on life insurance proceeds. Interest earned on those proceeds is taxable. The structure you choose can change the result, so the CPA reviews these points first.

• Transfers for value. IRC § 101 limits the exclusion when a policy is transferred for value. The excluded amount cannot exceed the consideration plus later premiums the buyer pays, except for transfers to the insured, a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is a shareholder or officer, and certain transfers that keep the transferor’s basis. Transfers of a life insurance policy can have tax consequences, so it is worth discussing each transfer with a CPA before it happens.
• Premium deduction. Under IRC § 264, no deduction is allowed for premiums if the taxpayer is directly or indirectly a beneficiary.
• Under IRC § 2042, insurance is included in the gross estate to the extent it is receivable by the executor, and for other beneficiaries if the decedent held incidents of ownership at death.
• Estate tax liquidity. If the decedent was a U.S. citizen or resident at death and an interest in a closely held business exceeds 35 percent of the adjusted gross estate, IRC § 6166 lets the executor elect to pay part or all of the estate tax in 2 to 10 equal installments. The buyout price should be reviewed alongside the estate plan.
• Commission disclosure. A CPA firm may not accept or pay a commission or referral fee in connection with the sale or referral of public accounting services, and a CPA firm that accepts a commission on a product or service must disclose that to the client in writing, under Fla. Stat. § 473.3205.

Life insurance is sold through Nischay Rawal, acting as a licensed insurance agent, as a service kept apart from the firm’s accounting work. He and the firm are paid by commission from the insurer on policies sold, and the complete details of that compensation are given to you in writing, in an engagement letter you sign, before any engagement begins.

Why Business Owners Work With NR CPAs & Business Advisors

NR CPAs & Business Advisors is a Miami CPA firm. It helps families, professionals, and business owners choose and buy life insurance. Its insurance work covers term and whole life, key person, buy-sell, estate planning, and NRI life insurance.

Our team looks at more than the policy itself. We review how the coverage affects cash flow, business ownership, and tax reporting.

Nischay Rawal, a licensed insurance agent, is the responsible agent for this page. The firm serves clients in Florida, including Miami, Fort Lauderdale, West Palm Beach, Orlando, Tampa, and Jacksonville. It also serves clients across the United States, including Indian-American households and business owners.

A coverage review starts with your agreement, your entity, and your current policies. It focuses on structure and ownership before any policy is recommended.

Common Questions About Buy-Sell Life Insurance

Next Step: Schedule a Coverage Review for Your Buy-Sell Agreement

To fund a buy-sell agreement with life insurance, start with a coverage review of the agreement and its policies. This step matters most when a co-owner’s death has triggered a buyout that nothing pays for.

Bring these items to your review:

• The buy-sell agreement and any amendments
• The most recent business valuation
• Entity documents, such as the articles, bylaws, or operating agreement
• Current policies and their owners and beneficiaries
• Each owner’s age and health history

Call NR CPAs & Business Advisors today to schedule your coverage review. You can also reach the firm through our contact page.