Questions and Answers about Business Life Insurance

We answer the most common questions about buy sell life insurance and key person insurance.

What is buy sell life insurance?

What kind of life insurance should I choose to fund a buy sell agreement?

Who should own the buy sell life insurance policy?

What is key person life insurance?

What kind of employee would be a key person?

 

Q: What is buy sell life insurance?

A: In many businesses, the partners, shareholders or co-owners will draw up a buy sell agreement that stipulates, among other things, what will happen when one of the owners passes away.

If the agreement calls for the surviving owners to purchase the deceased's interests, they can fund the purchase with life insurance. Quite simply, the tax-free death benefit paid from the policy can be used for this purpose.

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Q: What kind of life insurance should I choose to fund a buy sell agreement?

A: You can choose from several types of life insurance to meet your needs. If your business is likely to have a limited life span—say 10 or 20 years—you may find that term life insurance is attractive. It costs less than other forms of insurance and can be allowed to lapse when the business closes. Alternatively, if you foresee the business continuing to operate for a longer period of time, you may wish to choose a permanent life insurance policy. Permanent life insurance such as Universal Life, can be used if your business wants to lock in insurability and foresees other needs for insurance beyond the period that the buy sell agreement is needed. For example, you may want to fund the buy sell agreement up to retirement age but thereafter use the insurance for estate taxes.

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Q: Who should own the buy sell life insurance policy?

A: Generally, the simplest solution is for the policy to be held by the other partners or shareholders, as they will receive the death benefit tax-free. This is referred to as a cross purchase funding solution. Alternatively, the business can own the policy, in which case the tax-free life insurance proceeds will be paid into the company and the requirements of the buy sell agreement will be carried out as stipulated in the agreement. This is often referred to as a redemption or share purchase solution.

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Q: What is key person life insurance?

A: In many businesses, there is one person whose skills and intellectual capital are so significant that it would be difficult and expensive to replace this knowledge if that person passed away.

Key person life insurance is designed to provide the business with the working capital it needs to keep operating and to fund the recruitment and training of a replacement.

If the key person is the most significant contributor to the business—the business may not be able to continue without them. In that case, the key person insurance will compensate the business owners for the income they lose should the business close down.

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Q: What kind of employee would be a key person?

A: A key person is an employee or owner whose services are of such a nature that the business would suffer substantial financial loss due to the person's death.

These employees offer their employer knowledge, skills or talent that few others can imitate or duplicate. The industry they work in or the nature of their work may be so specialized that there are few others with the skills needed.

Many of these occupations have a component of design or research to them. Typically, the unique skills possessed by a key person are not totally acquired through education or even experience but are attributable in part to their own creativity, talents and interests.

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