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Life insurance to fund a buy-sell agreement

Protecting your business for the future

Why do we need a buy-sell agreement?

A buy-sell agreement sets out the terms under which the interest of the disabled or deceased shareholder will be sold. It also contains provisions for the transfer of ownership when you retire. As well, if properly funded, the shareholder’s family will receive fair market value for the shares. Thus, providing them with capital to help maintain their standard of living. Funding your Buy-Sell agreement with a Life Insurance policy may be right for you.

Photo of two businessmen shaking hands

A buy-sell agreement sets out the terms under which the interest of the disabled or deceased shareholder will be sold.

A properly Life Insurance funded buy-sell agreement can:

  • Assure creditors that funds will be available to pay bills.
  • Assure existing employees that the company will have the means to continue
  • Ensure a market for each shareholder’s interest in the business
  • Set the terms under which you and your fellow shareholders agree to buy and sell each others’ interest in the business
  • Ensures surviving shareholders have the necessary funds required to buy out the deceased shareholders interest
  • Provide for your family in time of need. The most cost-effective method to fund a buy-sell agreement, in the case of the death of a shareholder, is through life insurance. This approach helps ensure the required amount of capital will be available at the time it is needed should it become necessary to buy out an interest in your business.

Advantages of a Life Insurance funded buy-sell agreement to the deceased’s estate

  • Ensures a market for the shares and guarantee a buyer for the shares of the business
  • Provides heirs with a predetermined price for the shares

Advantages of  Life Insurance funded buy-sell agreement to the surviving shareholders

  • Protects them from unwanted shareholders, such as family members of the deceased
  • Allocates the shares in a manner agreeable to all shareholders
  • Establishes the method to determine the price of the shares
  • Ensures the funds exist to buy out the deceased’s shares

Determine the value of your business

While it’s ultimately your accountant’s responsibility to arrive at a value today to facilitate funding decisions, it’s important to understand some of the principles involved in the valuation process. There are a number of methods you and your accountant can use to determine a purchase price for a buy-sell agreement. The valuation clauses of the buy-sell agreement should give clear direction on the date the value is to be established. Below are advantages and disadvantages of three commonly used methods.

Fixed value method

The actual purchase price is specified in the buy-sell agreement and should be re-determined annually with the agreement updated accordingly.

Advantages

  • Simplicity and certainty
  • Shareholders can easily determine the price to be paid for their interests and plan accordingly

A buy-sell agreement is a plan that provides for an orderly change of ownership under certain circumstances; for example, when a business principal dies or becomes disabled. It’s designed to establish a value for the business, now and in the future.

Disadvantages

  • May be costly and there will be no definite value available for funding arrangements unless a valuation is completed today
  • As market conditions change, the fair market value can fluctuate significantly

Shotgun clause

An approach often used in buy-sell agreements is a shotgun clause. This clause applies when there is dissension among partners or shareholders, or a desire to sell. With this option, shareholders who want to sell shares offer them to other shareholders at a specific price. The other shareholders then have the option to purchase the shares at that price. Or, should they choose, they can sell their shares to the shareholder who made the initial offer to sell, according to the same terms and conditions as the initial offer. If the initial seller asks too high a price for the shares, the purchasers would decline the offer and demand the sale of their shares to the seller at that high price, or if the initial seller specifies a low price, they would be cheating themselves of a fair price.

Life Insurance Funded Buy Sell: Protection for the future

Establishing a properly funded buy-sell agreement between shareholders, or for a successor owner, provides security and the knowledge your business can continue to prosper even in the event of tragedy. Buy-sell agreements are complex and unique to your particular situation; therefore, you should consult the appropriate legal, accounting and tax experts for assistance in drafting a buy-sell agreement that meets the needs of your situation. Your advisor* can work with you and your other professional advisors to help determine a suitable buy-sell agreement and help ensure the appropriate insurance plans are in place to fund the agreement.

Disadvantage

  • Value must be re-determined each year and the agreement updated

Formula method

The purchase price is determined at the time of death by a formula stated in the buy-sell agreement. Some of the more common formulas used calculate the book value or adjusted book value of the business. Other formulas might base the value of the business on a multiple of earnings or a multiple of sales.

Advantages

  • No need for an annual review
  • Inexpensive to determine the purchase price using the formula method

Disadvantages

  • The terms, book value and adjusted book value have no generally accepted definitions and could
  • lead to potential disagreements, even if the terms are defined in the agreement.
  • Once set, these formulas don’t change to reflect changing business or economic conditions.
  • This method is not very useful where the formula cannot take into account the increasing values of property owned by the company or the value of goodwill.

Fair market value method

The purchase price is based on a fair market valuation of the business at the time of death. The agreement may call for a valuation to be performed by a specified licensed valuator or some other party such as the company’s accountant. It’s preferable to have a third party value the business to receive an objective value. As an alternative, the parties to the agreement may negotiate a price with arbitration procedures set out in the case of disagreement. The agreement should clearly exclude life insurance death proceeds from this calculation.

Advantages

  • Ensures the shareholders and family receive fair market value for their shares at the time the buyout is exercised
  • Should result in a fair solution for all parties.

All comments related to taxation are general in nature and are based on Canadian tax legislation, which is subject to change, and apply to Canadian residents. For the implications as they relate to individual circumstances, consult the appropriate legal, accounting or tax expert.

Preserve your wealth

A strategy to protect the value of your legacy

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A permanent life insurance policy can provide your beneficiaries with the funds necessary to pay taxes owing upon your death.

The Preserve your wealth strategy is designed for individuals who:

  • Have built-up significant wealth in capital assets
  • Have a second property that has appreciated in value
  • Want to keep a vacation home in the family
  • Are worried about leaving their family with a large tax burden
  • Want to leave their full estate to heirs or favourite charity
  • Want to provide funding for final expenses, outstanding debts, legal fees and taxes

The situation

You have worked hard to achieve a degree of financial success. As each year passes and you become financially independent, you may think your need for life insurance decreases. However, the largest burden on your estate can be the taxes owing on assets upon your death. This may force the sale of some or all assets, perhaps below fair market value, in order to pay the tax. The family may be forced to sell a cottage or vacation property to pay the taxes owing on its increase in value. This can potentially reduce the legacy you will leave to your heirs or favourite charity. Would you like to know how to preserve your wealth to ensure the full value of your estate is received by your heirs or favourite charity?

The strategy

A permanent life insurance policy can provide your beneficiaries with the funds necessary to pay taxes owing upon your death. Life insurance can be a cost-effective strategy to provide funds exactly when they are needed. A tax-advantaged permanent life insurance policy allows for the accumulation of cash values inside the policy, within certain legislative limits and without paying income tax on growth. The death benefit is paid to your beneficiaries tax-free upon your death. With a named beneficiary other than the estate, you can eliminate probate fees on the death benefit (not applicable in Quebec). The Preserve your wealth strategy should be reviewed with your tax advisor and accountant to ensure the strategy is appropriate based on your needs.

The Preserve your wealth strategy offers:

  • Permanent life insurance protection and client control of capital in a tax-advantaged insurance policy
  • Potential for tax-advantaged accumulation that transfers tax-free to beneficiaries upon your death
  • Funding to offset anticipated tax liability
  • Flexibility to change the policy beneficiary, and coverage amount (subject to any underwriting requirements)
  • The elimination of probate fees at death with a named beneficiary other than the estate (not applicable in Quebec) For more information about this and other estate planning material, contact your financial advisor!

All comments related to taxation are general in nature and are based on Canadian tax legislation, which is subject to change, and apply to Canadian residents. For the implications as they relate to individual circumstances, consult the appropriate legal, accounting or tax expert.

Inheritance With Tax-Advantage Permanent life Insurance

Inheritance With Tax-Advantage Life Insurance

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Tax-Advantage Life Insurance Inheritance

Are you thinking about leaving an inheritance for your children and grandchildren? You’ve worked hard to achieve a degree of financial success and have set aside non-registered investment funds. These funds are an inheritance for an adult child or a grandchild. You don’t want the tax burden and probate fees to reduce the legacy. Although you’re unlikely to ever need the money yourself, you’re concerned about the safety of your investments. This means you want access to the funds should your circumstances change. Also, you’re in a high marginal tax bracket and are frustrated with paying significant annual taxes on the growth of these assets.

Set Up Tax-Advantage Life Insurance as Inheritance

Purchase a tax-advantaged permanent life insurance policy with your adult child as the life insured and the designated contingent owner. Your grandchild (the child of the life insured) is named as the beneficiary of the policy. By transferring your non-registered assets into the policy, you’ll reduce your future annual tax burden. Funds invested in a tax-advantaged life insurance policy allow for accumulation of cash value inside the policy (within legislative limits), and you don’t have to pay income tax on this growth. At your death, because of certain income tax provisions applying to life insurance policies, you may transfer ownership of the life insurance policy to your adult child (who is the only life insured on the policy) without your estate paying any tax on the cash value growth. The transfer is also free of probate, executor and legal fees.

Upon the transfer of ownership of the policy to your adult child, he or she will have access to the cash value in the policy while he or she is living. Alternatively, your adult child can maintain the policy to be passed on at their death to your grandchild as a death benefit, again without taxes, probate or legal fees. The cash value in the policy remains completely accessible and in your control while you’re alive. Contact Solutions Financial today and they will customize your life insurance coverage and match your investment goals with your risk tolerance.

All comments related to taxation are general in nature and are based on Canadian tax legislation, which is subject to change, and apply to Canadian residents. For the implications as they relate to individual circumstances, consult the appropriate legal, accounting or tax expert.