How to Use Life Insurance to Fund a Buy-Sell Agreement
As a business owner, one of the most important — and overlooked — parts of succession planning is this question:
What happens to your business if a partner passes away?
Without a clear plan, the surviving owners could face financial strain, disputes with heirs, or even a forced sale of the business. That’s where a Buy-Sell Agreement comes in. It’s a legal contract that sets out how ownership shares will be transferred if a shareholder dies, becomes disabled, retires, or decides to leave.
But here’s the catch: even the best-written agreement can fail without proper funding. Some owners try to rely on accumulated savings, bank loans, or installment payments to heirs, but those approaches often strain cash flow, depend on creditworthiness, or create long-term risk if the business falters. That’s why the most effective way to ensure liquidity is to use life insurance.
Let’s break down three common methods for funding a Buy-Sell Agreement with life insurance.
The Criss-Cross Method
In this structure, each shareholder buys a life insurance policy on the other(s) and names themselves as beneficiary.
When a shareholder passes away, the surviving owner receives the tax-free insurance proceeds and uses them to purchase the deceased partner’s shares from their estate at fair market value.
Advantages:
- Simple, direct funding
- Estate can use capital gains exemption rules
- Proceeds are protected from corporate creditors
This method works best when there are only two or three shareholders — otherwise, the number of policies required can become unmanageable.
The Promissory Note Method
Here, the corporation owns and pays for the policies, naming itself as beneficiary.
When a shareholder dies, the company receives the insurance proceeds. It then pays those funds to the surviving shareholder(s) as a capital dividend, who in turn use them to fulfill a promissory note obligation to purchase the deceased’s shares.
Advantages:
- Premiums are evenly shared among shareholders
- Costs are typically lower since premiums are paid with corporate after-tax dollars
- Keeps ownership transitions clear and funded
This method is efficient in multi-shareholder setups and ensures the company helps facilitate the buyout fairly.
The Corporate Redemption Method
With this approach, the company owns the policies and is also responsible for buying back the deceased shareholder’s shares directly from their estate.
The death benefit provides liquidity, and the redeemed shares are cancelled, leaving the surviving owners with a larger proportional ownership.
Advantages:
- Premium costs are shared proportionately among shareholders
- Often the most tax-efficient option for larger corporations
- Defers some tax on capital gains at the first death
This method simplifies administration because only one set of policies is required, but it also ties the buyout structure directly to the corporation.
Which Strategy Is Right for You?
Each method has its strengths — and the right choice depends on your company’s structure, number of shareholders, and long-term goals.
- Criss-Cross: Best for two partners seeking simplicity.
- Promissory Note: Efficient for multiple owners where equal cost-sharing is key.
- Corporate Redemption: Often preferred for larger corporations looking for tax efficiency and streamlined funding.
Final Word
A Buy-Sell Agreement without funding is just words on paper. Life insurance ensures your business has the cash and certainty to transition ownership smoothly, protect surviving shareholders, and provide fair value to the estate of a deceased partner.
At Safe Horizon Financial, we help business owners put the right insurance solutions in place to fund their Buy-Sell Agreements. With proper funding, your succession plan can protect both your company and your family.
Disclaimer: The information contained in this article is provided for general informational purposes only and does not constitute financial, legal, tax, or investment advice. While we strive to ensure that the content is accurate and up to date, Safe Horizon Financial makes no guarantees regarding its applicability to your individual circumstances. Readers should consult qualified professionals (such as a licensed financial advisor, accountant, or lawyer) before making decisions based on the information presented. Safe Horizon Financial is not responsible for any actions taken or not taken as a result of this content.