The problem it solves
When a partner dies, their shares pass to their estate. The remaining partners could end up sharing the company with heirs who don’t know the business, while the family needs cash, not shares.
A shareholders’ buy-sell agreement defines who buys, at what price and how it’s paid. Life insurance provides the money exactly when it’s needed.
What is criss-cross insurance?
In a criss-cross arrangement, each partner owns, and is the beneficiary of, a policy on the other partner’s life, and pays its premiums. If one partner dies, the other receives the death benefit tax-free and uses it to buy the shares from the family, as set out in the agreement.
A simple example
Ana and Luis each own 50% of a company valued at $1 million. Ana owns a $500,000 policy on Luis’s life, and Luis owns one on Ana’s. If Luis dies, Ana receives $500,000 tax-free and buys his shares from his family at the agreed price. The family gets cash; Ana keeps control of the business. Illustrative figures.
Advantages
- Immediate liquidity for the purchase, without selling assets or putting the company into debt.
- The death benefit reaches the surviving partner tax-free.
- The buying partner acquires the shares with a tax cost equal to the price paid, which can reduce tax on a future sale.
- The money doesn’t go through the corporation, so it isn’t exposed to the company’s creditors.
- It’s easy to understand when there are only two partners.
Limitations
- Premiums are paid with personal, after-tax money — usually more expensive than paying them through the company.
- Costs can be unequal if one partner is older or in different health.
- With more partners, the number of policies multiplies: four partners need twelve.
- It’s hard to confirm that each partner keeps their premiums up to date.
- If a partner leaves the company, transferring the policies can have tax consequences.
Alternatives to consider
- Corporate-owned insurance: the company owns and is the beneficiary of the policies and pays premiums with corporate dollars; the benefit can be credited to the CDA and paid to shareholders tax-free.
- Holding company and demand note: a structure that shares the cost according to each partner’s ownership.
- Combinations: many companies use a mixed approach depending on age, health and the number of partners.
How to get started
- Get a reasonable valuation of the business.
- Draft or update the shareholders’ agreement with a lawyer.
- Choose the policy ownership structure with your accountant.
- Decide on the type of insurance: term for a set horizon or permanent for life.
- Review the business value and the coverage every one or two years.