For pharmacists interested in the possibility of pharmacy ownership, they quickly discover that there is a lot to learn beyond what pharmacy school taught us. The good news is that you don’t have to learn it all by yourself. That’s why I’ve been grateful to share some of the expertise and insights from Lawrence Barrett and Thomas Craft. Together they operate the Independent Pharmacy Consulting Group and have been sharing with us about the importance of a well-crafted and properly funded Buy-Sell agreement.
In this the 5th installment in the series, they share their ideas about utilizing a life insurance policy as part of the Buy-Sell agreement funding. This information is critical to ensuring the financial stability of a pharmacy when an owner needs to transfer their portion of the investment to another investor or partner. Please feel free to contact them for more information if you need help with this part of your business plan!
Six Things an Independent Pharmacist Should Consider Before Preparing a Buy-Sell Agreement
In the fifth installment of our six-part series we look at what type of life insurance should be used in funding a pharmacy Buy-Sell Agreement and how to determine which product is appropriate for your situation.
What Type of Life Insurance to Use in a Buy-Sell Agreement?
When selecting insurance for your Buy-Sell Agreement, you will succeed if you focus on matching the “product” to the “problem. The first question that arises is “how much insurance is enough?” Once determined, the premium costs may weigh in on what type of life insurance is used – term or permanent.
When the purpose of the insurance is to cover a death need only up to the shareholder’s 65th or even 70th birthday, term insurance is often used. It is usually purchased for a period of 10, 15, 20 or 30 years at a level premium. Beyond that level period, the coverage will run out, no longer be renewable, or experience a significant premium increase due to the advanced age of the insured.
Term life insurance does provide two distinct advantages:
- The initial outlay (premium) will be lower than permanent insurance and
- When the after-tax earnings of the business are high enough, the time value of money may favor using term, but only provided the company invest the difference in the business and the business profitability is continuous for the long-term. (Note: it works in theory but rarely in practice.)
A disadvantage of term insurance is it only provides protection against one triggering event – death. Permanent insurance may provide greater coverage for more than one triggering event and, therefore, be more economical.
The initial outlay of permanent life insurance is higher than the equivalent amount of term insurance however the advantages may outweigh the cost. Permanent life insurance is generally purchased to meet help the goals of a Buy-Sell Agreement where the owners will continue to work or hold their business interest in the pharmacy beyond ages for which term insurance is appropriate.
Permanent life insurance provides numerous advantages over term insurance:
- The life policy can be continued regardless of the ages or health of the shareholders and the premium may remain level indefinitely unlike term insurance which becomes prohibitively expense at advanced ages.
- The cash values in the policy can be used to provide a low cost loan or collateral assets for a business need or fund a lifetime buyout. The reason higher premiums are paid in early years is to internally build cash value in a tax-efficient manner to keep the policy in force until the insured’s actuarial death age when the cost of insurance becomes prohibitively expensive.
- Cash values can be used for the retirement of a pharmacist shareholder, serve as security for both the shareholders and pharmacy or used as a source of funds to make a down payment for the acquisition of the insured’s stock during life.
- Another important use of the tax-free cash value build-up inside the policy may be used to fund a disability buyout.
- In a family business where the business owner holds a significant interest in the pharmacy until death, the permanent insurance provides an estate planning advantage to non-equity family members allowing for equalization of the estate.
- Over the long run, permanent insurance is more useful in funding pharmacy business purchase agreements because of its flexibility.
- If corporate-owned life insurance has a waiver of premium provision, at the end of a six month waiting period, money previously used to pay life insurance premiums can now be used by the pharmacy to help pay for the disabled shareholder’s stock and indemnify the pharmacy for the loss of a key person.
Types of Permanent Insurance
Permanent life insurance varies based on the purpose or use of the insurance which may include a level death benefit or cash value build-up. Another consideration is whether the burden of risk falls on the policy owner or insurance company. Types of permanent policies include whole life, universal life, variable universal life, and indexed universal life.
Use of Existing Life Insurance
When using an existing life insurance policy, it is critical you be aware of the “transfer-for-value” rule under IRC §101(a)(2). Under the rules, if a policy or any interest in a policy is transferred for valuable consideration, the death proceeds will be exempt from income tax only up to the amount of consideration paid by the transferee and net premiums, if any, paid after the transfer. In other words, a life insurance death benefit can become fully or partially taxable.
In the sixth and final installment of our six-part series, we add a bonus on the tax consequences of using a Buy-Sell Agreement.
Lawrence C. Barrett and Thomas H. Craft are registered representatives of Lincoln Financial Advisors Corp.
Securities offered through Lincoln Financial Advisors Corp., a broker/dealer. Member SIPC. Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors, a registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Neither Lincoln Financial Advisors nor its representatives offer legal or tax advice. You may want to consult a legal or tax advisor regarding this information as it relates to your personal circumstances. 28601 Chagrin Boulevard, Suite 300, Cleveland, OH 44122. CRN-1036498-101414
Independent Pharmacy Consulting Group, LLC is not an affiliate of Lincoln Financial Advisors Corp.