Francois Marais

Buy and sell life assurance also has income tax implications. 

Received this monthly newsletter from Sanlam today, stealing it because its good to have good concise summarries of something as important as buy and sell insurance. Buy and sell life assurance also has tax implications that need to be carefully considered Buy and sell life assurance need to be supported by proper buy and sell agreements.

Credit to Sanlam for this article emailed to me.

When a co-owner of a business dies or become permanently disabled, the affected owner’s estate can be left severely exposed, but the remaining owners could also face potential challenges.

The potential challenges created for the affected owner’s estate are:

• The remaining owners might not have the resources to purchase the shares from the deceased owner’s estate.
• The deceased owner’s spouse may not want to participate in the business, which means that he or she is left at the mercy of the existing owners.
• The deceased or disabled owner may have had unique skills that he or she brought to the business, meaning that the business risk increases if those skills are no longer available to the business.
• The deceased owner may have earned a salary from the business, and when he or she died then his or her spouse cannot simply claim that salary, unless the spouse actually works in the business on the same basis as the deceased owner.
• If the permanent disabled owner received a salary from the business he/she would not be able to draw that salary anymore because of his/her inability to work.

The potential challenges created for the remaining owners are:

• The executor of the estate of the deceased owner might interfere in a business about which he or she knows nothing.  
• The executor might want to sell the deceased owner’s interest to the highest bidder, opening up the business to foreign investors.
• The existing owners may not have the funding to repurchase the deceased owner’s interest at that stage.

The primary purpose of a buy-and-sell arrangement is to provide the surviving owners with cash to purchase the interest of a deceased or disabled partner.

A buy-and-sell solution provides a smooth exit for an owner in the event of death or disability. This agreement ensures continuity of business in the event of the death or disability of an owner. The business owners, therefore, have to enter into a contract which stipulates that the remaining owner(s) will buy the interest of the deceased or disabled owner.

All the owners then take out insurance policies on one another’s lives to provide the funds to honour the agreement. It is also very important that the sum assured be updated from time to time to keep up with the value of the business and, therefore, the purchase price.

The alternative to insurance is to borrow the money needed to buy the deceased owner’s share from a commercial bank. However, even if the remaining owners are successful in obtaining such a loan, the terms and repayment period could possibly make it unaffordable from a cash-flow point of view. In most cases, insurance would therefore be the more affordable solution.