When business owners plan for surviving a ownership change or the loss of a key employee (due to death, retirement, or termination), they frequently incorporate life insurance as part of the process. Life insurance proceeds can be used to trigger buy-sell agreements and compensate for business/operational costs that come with the loss of a key executive.
A buy-sell agreement allows the remaining owner(s) to acquire the equity share of a withdrawing owner. The agreement typically restricts an owner’s ability to transfer his or her stake in the company and establishes the terms under which another owner or the business entity may acquire it.
Key person life insurance is another strategy that compensates a business against the losses that result from the death of a key employee. Here, the policy holding company receives a tax-free death benefit which can be used to pay for buy-sell agreements and other operational/legal costs. The company may arrange an exchange agreement that allows the insurance coverage to be transferred to a successor if the key person leaves the firm before retirement.
When insuring a key executive of your company, keep in mind that insurance premiums are not deductible business expenses, and life insurance cash values and death proceeds may trigger the corporate alternative minimum tax. In addition, you should consult with your legal and tax advisor to determine how a buy-sell agreement could affect your personal financial situation and your estate plan.