Funding a buy-sell agreement

The structures

Each has different tax, basis and administrative consequences depending on entity type, the number of owners and their ages. This is accountant-and-attorney territory, and the choice matters.

• Cross-purchase — each owner holds a policy on each other owner
• Entity purchase — the business owns policies on the owners
• Trusteed cross-purchase — a trustee holds the policies, simplifying arrangements with several owners
• Hybrid — the agreement selects the mechanism when the event occurs

The arithmetic problem with cross-purchase

With two owners, cross-purchase needs two policies. With four, it needs twelve. The number of policies grows quickly, and administering them becomes the reason people move to a trusteed or entity arrangement.

Worth working out before committing to a structure that becomes unmanageable.

The valuation review nobody schedules

This is the most common defect in these arrangements. Coverage gets set at a valuation from years ago and never revisited, so a business that has doubled in value has a buy-sell funded at half of what it needs.

Put valuation and coverage on the same annual calendar as the accounts. It's a short review and it prevents the failure the whole arrangement exists to avoid.

Points that catch people

• The valuation method in the agreement should be workable, not aspirational — a formula everyone can apply beats a number nobody updates
• Transferring a policy for consideration can trigger the transfer-for-value rule and make the death benefit taxable; take advice before moving policies between owners
• Disability and retirement triggers usually need separate funding from death
• Coverage should be checked when an owner joins or leaves
• The agreement and the policies must actually match each other

Get the sequence right

The attorney drafts the agreement, the accountant advises on structure and tax, and the coverage is arranged to match. Doing it in the other order produces policies that don't fit the agreement they're meant to fund.