Several issues come into focus when we address funding a Buy-Sell in the event of a premature death. They revolve around time, taxes, and cost effectiveness. As was mentioned earlier, a majority of Buy-Sell agreements are activated due to premature deaths. So then what is the best way to fund your Buy-Sell in the event of a death? While we have discussed a few other alternatives, accumulating cash, I believe there is a very strong case for using Life Insurance.
When we first examine the concept of time, Life Insurance is the clear winner. Very few know when we will die. So it’s critically important to accumulate a sufficient amount of cash to be able to achieve a funding buy-out of your business. All investments can do this. However, Life Insurance can do this the quickest. For simply pennies on the dollar, you immediately create a cash account. All other investments take many years to create the same amount of capital. The one exception being if you already have large cash accounts available. Some may be in that enviable position. Nevertheless, that capital is usually reserved for a specific goal, most notably retirement.
The case for Life Insurance becomes even more compelling when you factor taxes in the equation. I’m sure many know that all proceeds from Life Insurance are received tax-free to a beneficiary. There are certain instances when it does become taxable. However, by working with your accountant and a financial consultant, these pitfalls are easily avoided. We will be discussing this in greater detail but for now by complying with the written rules of Section101 (j), proceeds are received income tax-free. It is important to note that if you have incidents of ownership in a Life Insurance policy then it does become taxable FOR FEDERAL AND NEW YORK STATE ESTATE TAXES.
Lastly, it is very cost efficient from many perspectives. To begin with, all monies are guaranteed. They can be guaranteed on a level death benefit basis or in some instances on an increasing death benefit platform. It becomes imperative to add that one should review the credit ratings of companies. Later we will devote a whole section on this topic. Life Insurance, depending on the type one uses, can also be very flexible, both in terms of premiums and also in benefits.
Since this area is critically important to the full knowledge of Buy-Sell Agreements, we will be devoting about a dozen articles over the next several weeks on the different types of Life Insurance. How many types do you think there are?