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Using Insurance To Fund Buy/Sell Agreements
There are various ways to fund a buy/sell agreement – borrow the funds from a bank with installed payments to heirs by buyers and life insurance. Of all these options, life insurance provides the best solution as the cost of the insurance premium is considerably lower than other options.
With a universal life policy, the insurance and the savings elements are unbundled, and the policy owner can choose between a wide range of investment options in which to allocate the savings portion of the premium.
There are three main methods to fund these types of agreements:
1. Criss-Cross Method
Each shareholder purchases a life insurance policy on the life of the other shareholder(s) and names himself or herself as beneficiary. Subsequently, the shareholders and company complete a buy/sell agreement that requires the surviving shareholder(s) to purchase the shares of the deceased shareholder, usually at fair market value.
Upon the death of a shareholder, the surviving shareholder(s) uses the insurance proceeds paid from the deceased's life insurance policy to purchase the shares from the deceased shareholder's estate.
2. Promissory Note Method
With this method, the operating company purchases a life insurance policy on the life of each shareholder. The company is named as the beneficiary of the policies and a Buy/Sell Agreement is put in place requiring the surviving shareholder(s) to purchase the shares of the deceased shareholder at fair market value. Upon the death of one of the shareholders, the company receives the insurance benefit and pays the proceeds to the surviving shareholder(s) as a capital dividend, allowing them to honour the promissory note.
3. Corporate Redemption Method
The operating company purchases a life insurance policy on the life of each shareholder and the company is named the beneficiary of each of the policies. This method requires the company to purchase and cancel (or redeem) the shares of each deceased shareholder.