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The Alemian File: Why You Need a Buy-Sell Agreement


If you are part owner-of a business you need a buy-sell agreement with your business partner or partners. Such agreements outline in advance what will happen if a co-owner leaves the business.

If you are part owner-of a business you need a buy-sell agreement with your business partner or partners. Also known as a buyout agreement, it is a binding agreement between co-owners of a business that governs what happens if a co-owner dies or is otherwise forced to leave the business, or chooses to leave the business.

A buy-sell agreement needs to be fully funded in case one of the owners dies, becomes disabled, or is forced to leave the business due to some sudden and unexpected event. One of the most popular ways to fund a buy-sell agreement is with a permanent cash value life insurance policy. When using life insurance to fund buy-sell agreements, a life insurance policy is issued for each of the business owners. If one of the owners dies, the death benefit from the policy is used to buy the deceased owner’s shares from the deceased owner’s family.

The policy can be designed to grow in value as the business grows in value. The policy must be big enough to pay for the departing owner’s shares even if the company is worth many millions of dollars. If the business is worth over $5 million, the policy premiums can be financed, and the business only pays the interest on the loan. Payments on the loan principle can be deferred for up to 15 years, and then the bank is paid back in full from the cash value of the life insurance policy. This frees up cash for the business and/or the business owners who can use the money for other things.

In recent years, some life insurance policies are issued with what is known as living benefit riders. There are two types of living benefit riders. The first one is called a critical illness rider. It can provide a benefit of up to one million in cash, tax free if the insured is stricken with a covered critical illness such as a heart attack, stroke, cancer, blindness, ALS disease, and end-stage renal failure. The money can go to the business, or the owner who is sick, or both.

The second living benefit rider is called a chronic illness rider, it's a great supplement to long-term care coverage. It provides a benefit of up to $30,000 a month for up to five years if the insured cannot perform two of the activities of daily living. It’s also a benefit that can be used by the insured later on in retirement if the insured becomes very sick later in life.

As part of an exit strategy, when the business is sold the owners keep their life insurance policies and the policies pay the owners a lifetime tax-free pension.

Using the cash-value life insurance policy to fund a buy-sell agreement is a very smart business decision and here’s why: The business owners make money while they are in business, they make money when the business is sold, and they make money from the life insurance policies. In some cases they can literally make millions just from the life insurance policy, and they are guaranteed to never run out of money in retirement.

If you have questions send me an email to Check out my website Follow me on Twitter, connect with me on LinkedIn and absolutely make sure you come back here next week to Physicians Money Digest for another edition of The Alemian File.

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Victor J. Dzau, MD, gives expert advice
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