Life Insurance in Business - Part 2: Partnerships and Corporations

Part 2: Partnerships and Corporations

A partnership is a legal, unincorporated business relationship between two or more individuals who each contribute their own unique skills, talents and capital for the purpose of owning and operating the enterprise. Like the sole proprietor (see Part 1 of this series), each partner has unlimited liability with regard to the business; as such, business creditors may claim personal assets for payment of debts.

By law, when a partner dies, the surviving partner or partners must usually dissolve the business. The survivor becomes a liquidating trustee; liquidating the business, his or her own job, and the surviving family's source of income. This is because the disposition of the deceased's business asset is required in order to settle his or her estate.

To a large degree, the problems created by the death of a partner can be resolved by means of a properly constructed buy-sell agreement. If there are only two or three partners, a cross purchase plan is usually suitable. Each partner is bound by the terms of the plan and agrees to purchase a proportionate share of the deceased partner's interest. If there are more than three partners, the entity-type plan is usually recommended, whereby the partnership agrees to purchase the interest of a deceased partner.

The key element for partnership planning is the funding of the agreements. Life insurance is an ideal choice because it guarantees that the required amount of money will be available precisely when it’s needed. For example, a cross purchase plan covering two partners would require that each partner own, pay the premium for, and be the beneficiary of a life insurance policy on the life of the other partner.

If the partnership consisted of, say, five partners, then each partner would need to own four separate life insurance policies -- a grand total of twenty policies. For this reason an entity plan is usually recommended if there are more than a few partners. Under this type of agreement with the same five partners, the partnership would only need to have five policies.

A corporation is a legal entity that's owned by its stockholders. One of the characteristics that distinguish a corporation from the other business forms is its unlimited lifespan. When a key working stockholder dies, the corporation's existence continues. Also, a stockholder's risk is limited to his or her investment in the corporation. Personal assets are generally safe from the claims of the company's creditors.

The death of a key stockholder in a corporation would mean the loss of services of this important person and quite possibly loss of business income, as well. However, the most immediate effect would undoubtedly be the loss of income for the deceased's family. The choices available to the family would generally be to sell the deceased's stock, attempt to live off of any dividends that the corporation may pay, or assume a working position within the corporation. The sale of the deceased's stock would likely be the most viable alternative, provided that adequate planning has taken place and that is cash available for the purchase.

Business planning to resolve the problems created by the death of a stockholder usually involves the implementation of a stock purchase- or stock redemption plan. A stock purchase plan is similar to a cross purchase plan whereby a price is determined and each stockholder agrees to purchase a proportionate share of the deceased shareholder's stock. The purchase price is funded with life insurance; each shareholder owns, pays the premium for, and is the beneficiary of a life policy on the lives of the other stockholders. As with the cross purchase plan, this arrangement is only practical when there are just a few shareholders. In situations with more shareholders, the stock redemption plan is better suited. Under it, the corporation is the owner, beneficiary and premium-payer of the life insurance policies and also agrees to purchase the deceased's stock. For further information on the various types of purchase and redemption plans used by corporations, please read Part 3 of this article series: Corporate Life Insurance Strategies.