Business Uses of Life Insurance
MR. WATSON: Business uses of life insurance. Life insurance can be used in a business in a variety of ways.
- as a funding medium - to fund buy-sell agreements
- as a form of business interruption - to protect against the death of a key person
- as an employee benefit plan
MR. WATSON: A buy-sell plan is an arrangement to provide funding for the sale of the business upon the death of the business owner. It is an agreement between a business owner and anyone he chooses. Upon death, the spouse of the business owner agrees to sell the business -- at an agreed-upon price, to the person named in the agreement. Life insurance is used to fund the sale. An attorney drafts the agreement, setting forth the purchase price. The agreement is legal and binding.
MR. WATSON: There are basically three ways to operate a business:
Each type has its own funding method for a buy-sell agreement.
Sole Proprietor Buy-Sell Plans
MR. WATSON: The people you need to keep track of in the following story are the owner, the wife, and the employee. The owner owns a hot dog stand. A very profitable business. It provides all the niceties of life for him and his family.
MR. WATSON: The employee has been a trusted employee for many years and longs for his own hot dog stand in the future. The owner's wife wants nothing to do with this hot dog stand should her husband, the owner die.
MR. WATSON: So the owner enters into an agreement with the employee. The owner directs his wife to sell the business to the employee at a prearranged price upon his death. The owner's wife is going to sell the business if the owner dies, at a prearranged price, subject to re-evaluation every year, because the value of the business is going to change. But, what is it the employee doesn't have? Money. So....
- The employee buys a life insurance policy on the owner.
- The employee is the premium payor, the owner, and the beneficiary of the life insurance policy.
The employee, as beneficiary, takes the money, gives it to the wife. She goes away, and now he (the employee) owns the hot-dog stand.
MR. WATSON: That's a sole proprietor buy-sell agreement.