By Jessica Groskopf and Cindy Bojanski, CFP®,RICP®
Life insurance can be a key tool for farm and ranch businesses to provide tax-free death benefits at the death of the insured if the policy is structured correctly. This article will discuss using life insurance to fund a buy-sell agreement.
Sometimes farms and ranches want to limit who inherits farm or ranch assets at the death of an owner. Coming up with cash at the death of an owner can be difficult for the surviving parties. One solution to this issue could be the use of a life insurance policy to fund a buy-sell agreement.
To illustrate how this tool could work, we have two people. A parent and an on-farm child. The parent is the insured, and the on-farm child will be the owner and beneficiary of the policy.
The parent owns the majority of the farm assets. The on-farm child has siblings who are not involved in the operation. According to the parent’s estate plan, the on-farm child will have to “buy out” their siblings at the death of their parent.
To ensure the on-farm child has enough cash at their parent’s death, the on-farm child will do two things. First, they will enter a formal buy-sell agreement with their parent, stating that at their parent’s death, they would buy any farm/ranch asset from the estate, that they do not inherit, for a specific price. Second, the on-farm child will purchase a life insurance policy on the parent. The on-farm child will be the owner and beneficiary of the policy. At the parent’s death, the on-farm child would receive the death benefit, tax-free (if the policy is structured correctly), and purchase the farm from the estate.
Things to consider:
- Know exactly what is being included in the buy-sell agreement. In the scenario above, the on-farm child is only purchasing farm/ranch assets that they do not inherit.
- Is it legal? Get a properly written buy-sell agreement. Make sure the agreement clearly outlines who has the right to purchase, what assets that are included, any conditions of the sale, when the sale can be made (at death), and how the purchase price is determined. Make sure the agreement is dated, signed, notarized, and placed with the other estate documents.
- Is it affordable? The crucial question is if this tool is even feasible. The cost of a life insurance premium is based on the age and health of the insured, the amount of the death benefit, and the type of policy. For many families, the owner generation is an advanced age by the time they set up or share their estate plan. Sometimes the owner generation is simply not insurable. In other cases, the cost of the insurance is so high, this is an unusable tool. It should also be noted that some policies require the payment of the premium for the life of the policy. This is a long-term expense to the policy owner.
- What is the purchase price? One of the biggest struggles families face when using this tool is determining the purchase price in the buy-sell agreement. This is difficult because it is difficult to determine the true value of the assets at the time of the insured’s death, which could be decades from now. Often, we will use a future appraised value, or tax assessed value.
- What type of policy? There are many different types of life insurance policies. Work with a professional who understands the purpose of the agreement. They will help you select the right product for your needs. Term policies often don’t work in this scenario, because they expire after a certain amount of time either at a specific age or after a number of years.
- Are there more than two people involved? Life insurance backed buy-sell agreement as illustrated in this article works well when there is an owner and on-farm heir or two partners in business together. However, if there are more people involved in the ownership of the farm or ranch assets, these buy-sell agreements can get significantly more complex.
- How will the life insurance be owned? Recently, buy-sell agreements became more complicated with Supreme Court case Connelly v. US. Ownership of the policy for the purpose of buy sell agreements can be included in the estate if not structured properly.
Life insurance backed buy-sell agreements can be a useful tool. As always, work with a trusted attorney and insurance agent to develop these agreements.
To learn more about using life insurance in estate planning for farmers and ranchers, visit cap.unl.edu
Jessica Groskopf is a Regional Extension Economist with the Center for Agricultural Profitability at the University of Nebraska-Lincoln. Cindy Bojanski, CFP®,RICP® is a Financial Advisor at Coordinated Planning.