Many closely held businesses do not make formal plans to transition the business in the event of the premature death of a business owner, the lifetime transfer or sale of the business, or the retirement of one of the key business owners. Lack of planning can cause a business to fail because of the significant changes that are brought about due to these triggering events. By using a cross-endorsement buy-sell plan funded with a permanent life insurance policy, the funds required to transfer the business efficiently will be available.
A cross-endorsement buy-sell plan is a private split dollar arrangement that provides the business owner and his or her family with the liquidity needed to transfer the business when one of the business owners dies prematurely. Alternatively, since the business owner owns the life insurance policy outright under this arrangement, he or she can access the policy’s potential cash value to supplement retirement income or to fund a lifetime buyout of the business due to disability.
Moreover, the plan may also provide the estate liquidity needed in the future to account for the wealth created from the growth of the business or from a successful public offering of the company’s stock. Because of its inherent flexibility, a permanent life insurance policy is an adaptable financial tool that can address a business owner’s changing needs over time.
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Under a cross-endorsement buy-sell arrangement, the business owner purchases and owns a life insurance policy on his or her life while the other business partners purchase and own policies on each of their respective lives. The value of each policy is based on the projected value of the business and each business owner’s proportional interest in the business. The arrangement is structured as an endorsement split-dollar plan so that a portion or all of the death benefit can be leased for a “rental charge” to the other business owners to satisfy the obligation under the buy-sell agreement.
Consequently, each business owner will recognize rental income on what they charge on their own policy, offsetting the net cost of the plan. The business owner as owner of his or her own policy continues to have access to the policy’s potential cash values. To minimize the cash outlay needed to pay premiums, the company may make annual bonus payments to each business owner in the amount of the premium.
The value of the rental charge is based on the economic benefit cost of the death benefit, which initially represents only a fraction of the premium. The economic benefit cost is measured annually using either a government or insurance company rate table that takes into account the insured’s attained age and the amount of the death benefit being endorsed.
Arrangements Between Irrevocable Life Insurance Trusts