Life Insurance to Fund Buy Sell Agreements
Life Insurance to Fund Buy Sell Agreements
Jason Stolz CLTC, CRPC
When business partners build a company together, they invest more than capital. They invest years of effort, relationships, reputation, and often personal guarantees tied to loans or leases. Yet one of the most overlooked risks in any privately held company is what happens if one owner dies unexpectedly. Without a clearly drafted and properly funded buy-sell agreement, surviving partners can suddenly find themselves in business with a spouse, child, or estate executor who may have no operational experience or desire to participate. At the same time, the deceased partner’s family may urgently need liquidity, especially if much of their net worth is tied up in the company. A properly structured buy-sell agreement funded with life insurance creates clarity in advance and liquidity on demand, ensuring ownership transitions are orderly rather than chaotic. For owners navigating underwriting complexity or higher-risk industries, including life insurance for the marijuana industry, proper carrier positioning and case design are especially important to guarantee enforceable funding when it matters most. Business continuity planning also frequently overlaps with broader personal protection strategies such as protecting your funds in retirement, since many owners rely on the business itself as a core retirement asset.
A buy-sell agreement establishes the legal roadmap for what happens to ownership shares upon death, disability, or other triggering events. But the agreement alone does not solve the liquidity problem. If a partner’s equity is worth several million dollars, the surviving owners must have immediate access to capital to complete the purchase. Without funding, they may be forced to liquidate assets, borrow from lenders, dilute ownership with outside investors, or negotiate under emotional pressure with heirs. Life insurance solves that gap efficiently. The policy pays a death benefit — generally income tax-free — at the moment it is needed. That capital is then used to purchase the deceased owner’s interest at a pre-agreed valuation. Owners often pair buy-sell planning with other corporate risk strategies, including key person life insurance for executives, which protects revenue streams tied to critical individuals. For those evaluating the difference between the two protection types, our resource on key person vs. buy-sell insurance covers how each structure serves a different business continuity purpose and when each is most appropriate.
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Cross-Purchase vs. Entity-Purchase Buy-Sell Structures
Structurally, buy-sell agreements are typically organized as cross-purchase or entity-purchase arrangements. In a cross-purchase design, each owner holds a policy on the other owners. When one partner dies, the surviving partners receive the proceeds personally and purchase the shares from the estate. This model can increase the surviving owners’ tax basis and works well in small partnerships. In an entity-purchase, or stock redemption structure, the business owns the policies and redeems the deceased owner’s shares directly. This can simplify administration in companies with multiple shareholders. Hybrid agreements combine elements of both, allowing flexibility as ownership evolves. Determining the appropriate structure requires coordination with legal counsel and tax advisors to evaluate basis implications, corporate structure, and estate exposure. For business owners evaluating partnership-specific structures, our resource on partnership buy-sell agreement insurance covers how the structure and funding mechanics apply specifically to partnership arrangements. Our resource on comparing group vs. individual life insurance can also highlight why personally owned policies may not be sufficient for business succession needs and why individually structured buy-sell policies typically serve the purpose better.
Valuation Discipline and Keeping Coverage Aligned With Business Value
Valuation discipline is equally critical. A buy-sell agreement should clearly define how the business will be valued at the time of death. Some companies rely on a fixed price updated annually. Others use a formula based on EBITDA multiples, revenue, or independent appraisal. Without consistent updates, coverage can drift away from true enterprise value. Underinsuring creates shortfalls that must be financed elsewhere. Overinsuring wastes premium dollars and can complicate underwriting approval. Life insurance carriers will review financial documentation to confirm insurable interest and ensure requested death benefits align with economic risk. In certain cases — particularly when an owner has health concerns — pre-underwriting strategy becomes essential. Business owners with medical histories may benefit from reviewing guidance on life insurance with pre-existing conditions to understand how stability timelines affect approvals and ratings. Understanding how beneficiary designations and estate documentation interact with buy-sell structures is also important — our resource on per stirpes vs. per capita beneficiary designations covers how this documentation decision affects how proceeds flow to heirs in ways that interact with buy-sell execution.
The Connelly Decision — What Every Business Owner Needs to Know
The buy-sell life insurance landscape changed significantly with the U.S. Supreme Court’s unanimous ruling in Connelly v. United States — a decision that every business owner with a life insurance-funded buy-sell agreement should understand and act on. The Court held that life insurance proceeds received by a corporation under an entity-purchase (redemption) agreement must be included in the company’s total fair market value for federal estate tax purposes at the time of the owner’s death — and that the corporation’s obligation to redeem those shares does not reduce that valuation as an offsetting liability. The practical consequence is significant. Under the previous understanding many practitioners relied upon, a company’s obligation to purchase the deceased owner’s shares with insurance proceeds was viewed as offsetting the value of those proceeds in the estate tax calculation. The Supreme Court rejected that reasoning. The case involved two brothers who were the sole shareholders of a closely held corporation. When one brother died, the IRS included the full life insurance proceeds in the company’s valuation, resulting in substantially higher estate taxes on the deceased owner’s estate than the family anticipated.
For business owners with entity-purchase agreements funded by life insurance, the Connelly ruling creates meaningful estate tax exposure that was not previously anticipated — particularly as the historically high federal estate tax exemption is expected to be reduced, bringing more estates within the threshold where this matters. The ruling has renewed attention on cross-purchase agreements, which the Supreme Court specifically acknowledged as a viable alternative precisely because the insurance proceeds in a cross-purchase structure are held personally by the surviving owners rather than by the corporation — keeping them outside the company’s estate tax valuation. Business owners currently operating under redemption agreements should work with their legal, tax, and insurance advisors to evaluate whether converting to a cross-purchase structure, establishing an insurance LLC, or restructuring the agreement in other ways is appropriate for their situation. This planning decision intersects directly with broader estate planning considerations, including strategies for how premium financing works for estate planning where large policy amounts are involved.
Cross-Purchase vs. Entity-Purchase — A Practical Comparison
| Factor | Cross-Purchase Agreement | Entity-Purchase (Redemption) |
|---|---|---|
| Who owns the policies? | Individual owners personally | The business entity |
| Number of policies required | One per owner pair (N × N–1) | One per owner (simpler) |
| Step-up in tax basis | Yes — surviving owners receive stepped-up basis | No — no basis step-up for surviving owners |
| Connelly estate tax risk | Lower — proceeds outside company valuation | Higher — proceeds included in company valuation |
| Premium payment source | Personal funds of each owner | Business funds |
| Creditor exposure of policies | Protected — personally owned | Exposed to business creditors |
| Administrative complexity | Higher with multiple owners | Lower — one policy per owner |
| Cash value on balance sheet? | No — personally held | Yes — corporate asset |
Choosing the Right Policy Type — Term vs. Permanent
Policy type selection influences long-term reliability. Term insurance offers cost-effective coverage and may be suitable for younger partnerships with defined time horizons. However, businesses expected to operate indefinitely often prefer permanent insurance to eliminate expiration risk. Permanent policies can also build internal cash value, which may serve as a financial asset on the balance sheet depending on accounting treatment and policy ownership structure. Selecting financially strong carriers with consistent performance history reduces counterparty risk. For partners who have never applied for coverage individually, understanding the underwriting process — including what happens during a paramedical exam as explained in our resource on what is a life insurance exam — helps set expectations and streamline approval. For larger ownership interests or significant premium requirements, some business owners evaluate premium financing for estate planning to reduce the out-of-pocket premium impact of large buy-sell policies while maintaining the full death benefit protection.
Disability Buy-Out and Comprehensive Continuity Planning
Beyond death triggers, disability buy-out insurance can complement life insurance funding. If an owner becomes permanently disabled, disability buy-out coverage provides lump-sum capital after a waiting period to facilitate ownership transfer. Integrating both death and disability funding creates a comprehensive continuity plan. Business owners should also review beneficiary coordination, estate implications, and trust ownership where appropriate to avoid unintended tax consequences — particularly in light of the Connelly ruling, which makes the structural details of policy ownership more consequential than they previously appeared. Our resource on using a trust as life insurance beneficiary covers how trust-owned policies interact with buy-sell structures and when this approach is appropriate. For families who need to track documentation later, knowing how to find an old life insurance policy can simplify claims administration during already stressful periods.
A Practical Scenario — How Buy-Sell Funding Works in Real Life
Consider a scenario in which three partners own a technology consulting firm valued at $9 million. Each owns one-third. Without insurance funding, the death of one partner creates a $3 million liquidity obligation. If profits are reinvested and working capital is tight, financing that buyout may strain operations or require bringing in an outside investor. Now contrast that with a funded agreement supported by $3 million in properly structured life insurance per partner. Upon death, the proceeds arrive promptly. The surviving partners purchase the shares. The deceased partner’s family receives fair value without prolonged negotiation. Employees, clients, and vendors observe stability rather than uncertainty. The funding mechanism transforms a potential crisis into a controlled transition. For larger ownership interests, some business owners also evaluate wealth transfer strategies the affluent use to protect heirs to coordinate buy-sell funding with broader estate and generational planning objectives. For business owners who also want to understand how life insurance integrates with comprehensive financial planning, our resource on what wealthy investors hold beyond the stock market provides useful context on how protection strategies fit within a holistic financial picture.
Buy-sell planning is not limited to large corporations. Professional practices, closely held family businesses, and multi-owner service firms face identical risks. In many of these companies, the majority of each owner’s personal net worth is concentrated in the business itself. Without liquidity planning, that wealth becomes illiquid at the exact moment heirs need access. Coordinating buy-sell funding with broader retirement and estate planning ensures the company remains both an operational asset and a financial cornerstone. The high-risk life insurance services we provide are particularly relevant for business owners whose occupations, health histories, or business types require specialized underwriting approach and carrier positioning. And for clients concerned about how the MIB record affects reapplication if an initial application is declined, our resource on what MIB is in insurance explains how this reporting system works and why pre-underwriting strategy before any formal application is submitted is so important for business owners with complex histories.
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Buy-Sell Agreement Life Insurance — Frequently Asked Questions
A buy-sell agreement is a legally binding contract that establishes what happens to a business owner’s equity stake when a triggering event occurs — most commonly death, but also disability, retirement, or voluntary departure. The agreement creates the legal roadmap for ownership transition, but it does not solve the liquidity problem on its own. If a partner’s equity is worth several million dollars, the surviving owners need immediate access to that capital to complete the purchase — without it, they may be forced to borrow under pressure, bring in outside investors, or negotiate with heirs under emotionally difficult circumstances. Life insurance solves this gap efficiently. The death benefit arrives at the moment it is needed, is generally income tax-free, and can be used immediately to purchase the deceased owner’s interest at the valuation pre-established in the agreement. Without insurance funding, a well-drafted agreement is simply an unfunded obligation — a promise without the means to fulfill it when it matters most.
In a cross-purchase agreement, each owner personally holds a life insurance policy on the other owners. When one partner dies, the surviving partners receive the death benefit personally and use it to purchase the deceased owner’s shares directly from the estate. This structure provides the surviving owners with a stepped-up tax basis equal to the fair market value paid at the time of purchase, which can meaningfully reduce capital gains taxes if the business is later sold. In an entity-purchase or stock redemption agreement, the business entity owns the policies and pays the premiums. When an owner dies, the business receives the death benefit and redeems the deceased owner’s shares directly from the estate. This structure is administratively simpler because only one policy per owner is required, but surviving owners do not receive a basis step-up. The choice between structures has meaningful tax and legal implications that require coordination with legal counsel, CPAs, and insurance advisors — particularly in light of the Connelly v. United States ruling, which significantly changed the estate tax analysis for entity-purchase structures.
The U.S. Supreme Court issued a unanimous ruling in Connelly v. United States holding that life insurance proceeds received by a corporation under an entity-purchase redemption agreement must be included in the company’s total fair market value for federal estate tax purposes at the time of the owner’s death — and that the corporation’s obligation to redeem the deceased owner’s shares does not reduce that valuation as an offsetting liability. The practical consequence is that business owners with redemption agreements may face higher-than-anticipated estate tax on the deceased owner’s estate, because the life insurance proceeds held by the company inflate the company’s value in the estate tax calculation. The decision has renewed focus on cross-purchase agreements, which keep insurance proceeds outside the company’s valuation because they are held personally by surviving owners rather than by the corporation. Business owners currently operating under redemption agreements should work with their legal, tax, and insurance advisors to evaluate whether restructuring is appropriate — as the federal estate tax exemption is expected to decline from historically high levels, bringing more estates within the threshold where this distinction matters significantly.
The amount of life insurance needed for a buy-sell agreement corresponds to the value of each owner’s equity stake in the business at the time of any triggering event. If a company is valued at $6 million and three partners each own one-third, each partner’s interest is worth $2 million — so each partner needs $2 million in coverage to fund the potential purchase of their interest. The challenge is that business valuations are not static. A company worth $6 million today may be worth significantly more several years from now, while coverage amounts can lag if the agreement is not regularly reviewed. Underinsuring creates a shortfall that surviving owners must fund from other sources — often at the worst possible time. Overinsuring wastes premium dollars and can trigger carrier scrutiny of insurable interest. Most advisors recommend building valuation review into the buy-sell agreement itself — specifying that the business will be appraised annually or that a defined formula will be applied consistently — and that insurance coverage will be updated to match the current valuation at each review cycle.
Both term and permanent life insurance can be appropriate for buy-sell funding, and the right choice depends on the partnership’s time horizon, budget, and financial goals. Term insurance is the lower-cost option and can be well-suited for younger partnerships with defined horizons or for situations where the primary goal is cost-effective coverage during the years of highest business growth. The risk with term is expiration — if the owners are still operating the business when a twenty or thirty-year term policy expires, they face the cost and health underwriting challenges of replacing coverage at older ages. Permanent insurance eliminates expiration risk and may be preferable for businesses expected to operate indefinitely, partnerships where the owners are older, or situations where the cash value accumulation of a permanent policy represents a financial asset for the business or the individual owners. In entity-purchase structures, the cash value of permanent policies appears as a corporate balance sheet asset. In cross-purchase structures, it belongs to the individual owner and can be converted or transferred when the business relationship ends.
Yes — in many cases, business owners with health histories can still obtain life insurance for buy-sell funding, though the process requires more strategic carrier selection and case presentation than standard applications. The key factors are the nature of the health condition, its current stability, the documentation available, and the time elapsed since any diagnosis or treatment. Some conditions that might result in automatic declination at one carrier may be approvable at table rating at another carrier whose underwriting guidelines are more favorable for that specific history. Pre-underwriting strategy — evaluating the most likely outcome at multiple carriers before any formal application is submitted — is particularly important for business owners with health concerns because a formal declination creates a Medical Information Bureau record that can complicate subsequent applications. At Diversified Insurance Brokers, we specifically evaluate carrier options for business owners with complex medical histories before submitting any application, identifying the carriers most likely to produce approval and the best available rating for each individual situation.
A well-designed buy-sell agreement addresses disability as a triggering event alongside death — and disability buy-out insurance provides the funding mechanism for this scenario in the same way that life insurance funds the death trigger. Disability buy-out coverage provides a lump-sum benefit after a defined waiting period — typically twelve to twenty-four months — when an owner becomes permanently and totally disabled and can no longer contribute meaningfully to the business. Without disability buy-out funding, the surviving active partners face the same liquidity challenge as a death buyout: they owe fair value for the disabled partner’s equity interest but may not have the capital to complete the purchase. Integrating both life insurance and disability buy-out coverage into a comprehensive buy-sell agreement creates a complete continuity plan that addresses the two most common involuntary ownership exit scenarios. Some agreements also address voluntary exit — retirement, divorce, or partner disputes — with different mechanisms, and the full agreement should be reviewed with legal counsel to ensure all triggering events are covered.
Most advisors recommend reviewing buy-sell agreements — including both the legal document and the insurance funding — at least annually, and also upon any significant business or personal change. Significant triggers include meaningful changes in business valuation, the addition or departure of owners, a major acquisition or expansion, changes in each owner’s personal financial or estate situation, and any ownership structure changes. The legal agreement, the valuation methodology, and the insurance coverage should all move together — if the business has grown significantly but the insurance coverage has not been updated, the agreement is effectively underfunded and surviving owners will face a shortfall when the funding is needed most. The Connelly ruling has added a specific reason to review the structure of the agreement itself for any business using a redemption arrangement, since the tax implications have changed in ways that merit professional evaluation. At Diversified Insurance Brokers, we proactively support our business owner clients in conducting these reviews as part of ongoing policy management.
Generally, no — life insurance premiums paid in connection with a buy-sell agreement are not deductible as a business expense, regardless of whether the policies are owned by the business or by the individual owners. The IRS treats these premiums as a capital expenditure rather than an ordinary business expense because the business or owners are the beneficiaries of the policy — they are essentially purchasing an asset for themselves rather than a deductible operating expense. This non-deductibility is a consistent feature of business-owned life insurance and is well-established in tax law. The corresponding tax benefit comes on the other side: the death benefit received is generally income tax-free to the beneficiary — whether that is the individual owners in a cross-purchase structure or the corporation in a redemption structure, subject to the alternative minimum tax considerations that apply in certain corporate entity-purchase arrangements. Business owners should work with their CPAs and insurance advisors to understand the full tax picture for their specific ownership and agreement structure.
Buy-sell life insurance is not a commodity placement — it requires matching the right carrier and policy structure to each owner’s age, health history, and the legal and tax requirements of the agreement. A captive agent representing a single carrier can only present that company’s underwriting approach, pricing, and policy options regardless of whether they are the most appropriate for the specific situation. Diversified Insurance Brokers is an independent brokerage representing over 100 carriers, which means we can identify the carrier whose underwriting guidelines are most favorable for each owner’s individual health and financial profile, compare pricing and policy structures across the market, and ensure the placement is coordinated with the legal and tax requirements of the agreement. We also have specific expertise in navigating pre-underwriting strategy for business owners with complex health histories, ensuring that the application process is managed in a way that avoids unnecessary MIB complications and produces the best available rating for each individual. Our goal is a buy-sell funding structure that is correctly documented, correctly owned, and correctly structured for the post-Connelly planning environment — so the agreement performs as intended when it matters most.
About the Author:
Jason Stolz, CLTC, CRPC, DIA, CAA and Chief Underwriter at Diversified Insurance Brokers (NPN 20471358), is a senior insurance and retirement professional with more than 25 years of real-world experience helping individuals, families, and business owners protect their income, assets, and long-term financial stability. As a long-time partner of the nationally licensed independent agency Diversified Insurance Brokers, Jason provides trusted guidance across multiple specialties—including fixed and indexed annuities, long-term care planning, personal and business disability insurance, life insurance solutions, Group Health, and short-term health coverage. Diversified Insurance Brokers maintains active contracts with over 100 highly rated insurance carriers, ensuring clients have access to a broad and competitive marketplace.
His practical, education-first approach has earned recognition in publications such as VoyageATL, highlighting his commitment to financial clarity and client-focused planning. Drawing on deep product knowledge and years of hands-on field experience, Jason helps clients evaluate carriers, compare strategies, and build retirement and protection plans that are both secure and cost-efficient. Visitors who want to explore current annuity rates and compare options across multiple insurers can also use this annuity quote and comparison tool.
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