When you are planning your estate after having worked for a company all of your life, you have particular challenges. However, small business owners who are involved in partnerships have many of the same circumstances to address and then some. When you are working for someone else or retired, your assets are your own to situate as you see fit. But when you are the co-owner of a business, your share may represent a large portion of your overall net worth.
So when you are planning your estate you have to find a way to extract that share for the benefit of your family without doing any damage to the business and the partners that you will be leaving behind. And, of course, you would like your partners to protect you in the same manner as they plan their estates.
This is often done through the execution of buy sell agreements. There are two commonly used approaches to this succession strategy and they both involve the purchase of life insurance. The first one we would like to highlight is the cross-purchase plan.
The way it works is that each of the partners takes out a life insurance policy on every other partner. The total value of the policies held by the surviving partners is calculated to equal a partner’s share in the business. When one of the co-owners passes away, the proceeds from the insurance policies are used to buy the deceased partner’s share in the business from his or her heirs.
The other type of buy sell agreement that is often used is called the entity purchase plan. With this method the total value of each partner’s share is valuated by mutual agreement. Then the business entity itself purchases a life insurance policy on each of the co-owners. When one of them dies, the business uses the insurance benefit payment to buy the share owned by the deceased from his or her estate.