Choosing Life Insurance for a Buy‑Sell Agreement

A buy‑sell agreement needs a life insurance policy that can fund the purchase of a deceased partner's share. The most common choice is a paid‑up, non‑forfeiture life insurance policy, often a 20‑year term or a whole‑life policy with a paid‑up rider, because it guarantees a cash value that can be used to buy the share immediately.

Why Paid‑Up or Non‑Forfeiture Matters

In a buy‑sell, the policy must be available at the moment of death, not subject to a waiting period or premium payments that could delay the transaction. A paid‑up policy, once fully funded, stays in force without further premiums, ensuring the cash value is ready for the buy‑sell. Non‑forfeiture riders on term life allow the policy to convert to a paid‑up status after a set period, providing flexibility while maintaining the ability to fund the agreement.

Whole‑Life vs. Universal Life Options

Whole‑life insurance offers a guaranteed death benefit and a cash value that grows at a fixed rate. This stability can be appealing when the buy‑sell agreement requires a predictable payment amount. Universal life, with flexible premiums and a variable cash value linked to interest rates, can provide higher growth potential but introduces more risk. For most small businesses, the certainty of whole‑life is preferred because the agreement's terms typically specify a fixed purchase price.

Policy Design and Agreement Alignment

When drafting the buy‑sell, align the policy's death benefit with the agreed purchase price. If the business value is $1 million and each partner owns 50%, the policy should have a $500 k benefit. The policy's maturity date should match the agreement's expected duration—often 20 to 30 years—to allow sufficient time for the cash value to accumulate.

Funding Strategies

Funding the policy can be handled through the business's operating agreement, where a portion of profits or a dedicated escrow account pays the premiums. Alternatively, the partners can set up a 1031 exchange or a trust to hold the policy, ensuring it remains outside the probate process and directly supports the buy‑sell.

Key Takeaways for Small Businesses

• Choose a paid‑up or non‑forfeiture life policy for immediate liquidity.
• Whole‑life offers guaranteed benefits; universal life offers growth potential with risk.
• Match the death benefit to the buy‑sell price and set a maturity that aligns with the agreement.
• Use business funding or a trust to maintain premium payments and protect the policy.