Business partners can purchase life insurance policies for the lives of each co-owner. In the event of the passing of a co-owner, the other owners can receive a lump-sum benefit equivalent to the departing owner's interest in the company.
At the same time, the deceased's family members can be compensated. Let's take a closer look at how buy sell insurance works.
What is a buy and sell insurance agreement?
A buy and sell agreement is an integral part of a business succession planning process. When a partner is unable to continue running the business due to death or disability, a buy and sell life insurance agreement can protect the business, especially for the surviving owners.
Buy/sell agreements can also provide cover for events other than death and disability. This can include:
Divorce or separation (if the owners are married or in a de facto relationship)
Retirement
In some cases, bankruptcy
What are the main benefits of buy-sell life insurance agreements?
Mutual benefit. Not only does the family of the deceased benefit through this agreement, but the company does not experience any financial loss.
Extends cover to serious illness and injury. Buy-sell life insurance can also be used to cover total permanent disablement or serious medical trauma.
Policies can be owned in various ways. Cover can be owned individually, cross-owned (owned on behalf of the lives of other owners), or owned by a super fund trustee on behalf of those insured.
Key components of a buy and sell life insurance agreement
Guarantee to buy the owner’s shares. The trigger events for a buy/sell agreement are always mentioned in the agreement and all the owners offer a guarantee that the shares of an owner will be purchased if any of the trigger events occur.
Purchaser of the owner’s shares. The agreement will also mention who has to buy the shares of the departing owner. The remaining owners may be bound to purchase the shares of the departing owner, or the company itself may be required to affect a buyout of the shares.
Valuation of the departing owner’s interest in the business. One of the main features of a buy/sell agreement is the valuation of the shares of the departing owner. The interest is typically valued as per the market rate of the shares at the time the trigger event occurred.
How to fund the buyout. The buyout of the shares of the departing owner is typically funded through life insurance policies on the owner’s lives. These policies generally include total and permanent disability, and trauma cover in some instances.
Speak with a broker about your specific buy and sell insurance needs
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5 ownership structures of buy and sell life insurance agreements
When life insurance is utilised to fund a buy and sell agreement, the business owners/partners must consider an ownership structure that is appropriate to their individual situation and objectives. There are 5 ownership structures for buy/sell life insurance agreements and these include:
In this ownership structure, business owners hold an insurance policy on their own lives. When a trigger event occurs, the departing owner or their estate is generally required to give up their share of the business to the surviving owners. Pros and cons include:
Pros
Cons
Flexibility to change the policy arrangements and alter the arrangement if new partners join or existing owners leave the business.
Life, TPD and trauma policies are generally not subject to Consumer Goods Tax (CGT).
The buy and sell agreement must be worded carefully to ensure that it meets the desired outcomes of the parties involved.
Issues may arise if the individual does not own the business assets in their own name, and instead under a third party, which could be a spouse, a company or a family trust.
Business owners may pay different premium rates for their policies, where one is a much higher amount than the other.
Cross-ownership
With this type of ownership, each shareholder owns an insurance policy on the other owners of the business. Any insurance proceeds can be used by the surviving owners to purchase the departing owner's share of the business. Pros and cons include:
Pros
Cons
Easy to implement with simple documentation required
No CGT is payable on life policies
Issues may arise if the individual does not own the business assets in their own name, and instead under a third party, which could be a spouse, a company or a family trust.
If there are multiple owners in the business, the cost of owning multiple policies can be significant.
Corporate ownership
In a buy/sell life insurance agreement with corporate ownership structure, the business partners do not own life insurance policies on each other. The corporate entity owns the insurance policies on behalf of the owners of the business.
So, in the event of death or permanent disability of one of the owners, the entity will buy out the departing owner's share of the business using the proceeds from the insurance policy. Pros and cons include:
Pros
Cons
Easy to understand and implement
Centralised management and payments, as the company will own all the insurance policies
Easier to add and amend insurance policies when there are changes in ownership compared to cross-ownership agreement
TPD and trauma insurance proceeds are likely to be subject to Capital Gains Tax (CGT).
Insurance policy benefit may increase the business value, which in turn may affect the CGT liability for the surviving owners.
There may be some additional tax implications on the benefit payment from the company to the departing owner.
Discretionary trust ownership
With discretionary trust ownership structure in a buy/sell agreement, an independent trustee of a discretionary trust has been appointed to hold insurance policies on behalf of all of the lives insured.
When a trigger event occurs, the trustee will then divide the proceeds of the policy to the continuing owners, which can be used to purchase the departing owner's interest in the business. Pros and cons include:
Pros
Cons
More flexible to accommodate changes in business ownership
Tax treatment for trust ownership is generally more complicated and it is recommended to seek professional advice from a tax specialist.
CGT may be payable on TPD and trauma policy proceeds.
Setting up a trust will require initial and ongoing costs.
Superannuation ownership
This structure can be considered as a variation of self-ownership, as the insurance policies are owned and structured through a superannuation fund, as opposed to under each of the business owners' names.
Determine the value of your business for the purpose of a buy and sell insurance agreement
There are 3 types of valuation methods to help determine the value of your business for a buy and sell insurance agreement:
Current market value
The Australian Taxation Office (ATO) will most likely consider the validity of a business interest transfer under a buy and sell agreement when it occurs at market value.
Current market value with indexation
You also nominate the sums insured based on the current market value of the business, and keep up with changes of business value amount over time by having them indexed to inflation or by the anticipated growth rate of the business.
Formula-based valuation
This formula should reflect an industry standard and be appropriate for the specific business. The value of the business over the years must also be reviewed by using this calculation.
Generally, a business accountant will conduct an assessment on the valuation and provide confirmation on whether or not it is acceptable on ordinary commercial terms. This may be an underwriting requirement prior to insurance being offered.
Tax treatment for different buy/sell insurance agreements
Ownership type
Are premiums tax-deductible?
Tax on payouts for life insurance
Tax on payouts for TPD & Trauma
Transfer of ownership
Self/principal
No
No CGT (if the payout is used for the original beneficiary)
No CGT
Assessable for CGT even though the departing owner does not receive any payment for their share of the business.
Cross
No
No CGT (if the payout is used for the original beneficiary)
No CGT (if the benefit payment is received by relatives of the policyholder)
Assessable for CGT
Corporate entity
Yes
Assessable for CGT
May be subject to CGT
Assessable for CGT
Discretionary trust
No
No CGT (if the payout is used for the original beneficiary)
May be subject to CGT
Assessable for CGT
Superannuation fund
Yes
Can depend on:
Whether or not the beneficiary is a dependent
How the benefit is paid – lump sum or income stream
Age of the life insured
The eligible service date, date of death/cease to work due to a disability, and retirement date
Conditions of release for TPD benefit payment
The super fund balance of the member
Can depend on:
Whether or not the beneficiary is a dependent
How the benefit is paid – lump sum or income stream
Age of the life insured
The eligible service date, date of death/cease to work due to a disability, and retirement date
Conditions of release for TPD benefit payment
The super fund balance of the member
Assessable for CGT
Why compare life insurance with Finder?
You pay the same price as buying directly from the life insurer.
We're not owned by an insurer (unlike other comparison sites).
We've done 100+ hours of policy research to help you understand what you're comparing.
Frequently asked questions about buy sell insurance agreements
A buy sell insurance agreement is a contractual agreement that allows the transfer of a business to any remaining owners if one partner dies or suffers a severe illness or injury that means they cannot stay in the company.
Put simply, a buy sell life insurance agreement covers the risk of significant financial loss to you and your partners in the event one of you suddenly dies or become disabled. With a buy/sell life insurance agreement in place, you can help to ensure a smooth business transition, even in difficult times.
Buy/sell agreement is a convenient and hassle-free solution for business owners and their loved ones while preserving the continuity of the business.
To determine the level of cover that you and your business partner/s may need, consider the value of each owner's share of the business. This value amount should generally reflect the sum insured on the buy and sell life insurance agreement. It's important that the business owners review this amount on an annual basis to ensure adequate cover is in place.
For example, if the business has 2 owners and each has an equal share of a business with a value of $2 million, the amount insured on the life of each partner should be $1 million on a buy/sell life insurance agreement that will provide cover for death, TPD cover and possibly trauma.
James Martin was the insurance editor at Finder. He has written on a range of insurance and finance topics for over 7 years. James often shares his insurance expertise as a media spokesperson and has appeared on Prime 7 News, WIN News, Insurance News, 7NEWS and The Guardian. He holds a Tier 1 General Insurance (General Advice) certification and a Tier 1 Generic Knowledge certification, both of which meet the requirements of ASIC Regulatory Guide 146 (RG146). See full bio
James's expertise
James has written 204 Finder guides across topics including:
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