What Can a Buy-Sell Plan Do for Your Small Business

In 2016, there were 28.8 million small businesses according to the Small Business Administration. Small Business accounts for 99.7% of U.S Businesses, which employee 56.8 million people. Here in Carteret County, the overwhelming majority of businesses are small businesses. Many are owned by partners while others are entities (C or S Corps).

No matter the ownership or number of employees, one issue that should be of concern is the death of one of the owners.  This occurrence brings several questions. What will happen to the business? Will the deceased owner have a family member who wants to step into his/her position? If so, will this person be qualified to do so? What impact will the death have on the operational and financial stability of the business? These issues and others can be addressed by a Buy-Sell Agreement funded with life insurance.

There are two types of Buy-Sell Agreements, Cross Purchase, and Entity Purchase. A Cross Purchase Agreement is usually best when a business has 2-3 owners.  In this type of agreement, the partner(s) purchase a life insurance policy on each other.  The death benefit will be approximately equal to an agreed upon purchase price. The owner and the beneficiary is the same person and the other partner is the insured. The owner pays the policy premiums which are not tax-deductible.  At a partner’s death, the surviving partner(s) receive a death benefit income-tax free from the life insurance policy owned on the deceased. The surviving partner(s) use the life insurance proceeds to buy the deceased partner’s share of the business from his/her estate at the agreed upon purchase price.  

An Entity Purchase is best used when a business has 4 or more owners. The Business and the owners enter into an entity purchase buy-sell agreement.  The Business purchases a life insurance policy on each owner. The Business is the owner and beneficiary of each policy.  

The Business pays the policy premiums which are not tax-deductible. At an owner’s death, the business receives a death benefit tax-free from the life insurance policy. The Business uses the policy proceeds to buy the deceased partner’s share of the ownership from his/her estate at the agreed upon purchase price.

With any business sale/purchase, there will be taxes involved. When it comes to the taxation of a buy-sell agreement, there are some similarities and differences between the cross-purchase and entity agreements. In both agreements, the Death Benefits are received tax-free by the partner(s) or business; however, make sure policy ownership is properly arranged so the death benefits will not be included in the deceased’s estate.  Also, in both cases, if the amount received by the estate equals the fair market value of the partnership or business at the time of death, there will be no taxable gain for federal income tax purposes. In an Entity Purchase, the business must obtain notice and consent from the insured prior to the policy being issued otherwise the death benefits will not be received tax-free. In addition, with an Entity Purchase, some C Corporations may be subject to the Alternative Minimum Tax (AMT).

A Buy-Sell Plan is a strategy most small businesses should consider. However, it is important to assemble the appropriate team to make sure the plan is structured correctly.  An attorney is required to draft the agreement so it will be legal and binding.  A Tax Professional is needed to make sure the agreement provides the desired tax results. Finally, an Advisor/Agent is necessary to write and service the life insurance policies. When done correctly, a buy-sell plan can provide an orderly succession of ownership for a business at a difficult time.

(Note- In the case of a single owner business, the owner may enter into a buy-sell agreement with an employee or interested buyer.)

Matt Dressel is the Owner of the Independent Financial Solutions Group, a Registered Investment Advisor. He is an Investment Advisor, Life Insurance Agent and does Financial Planning.  If you have any questions about this article, he can be reached at 252-515-0242 or matthewdressel.ifsg@gmail.com.

(Life Insurance Benefits could be subject to the claims-paying ability of the Life Insurance Company.)

Role of Dividends

Dividends should be an important part of any investment plan.  Unfortunately, many investors don’t consider dividends and even overlook them.  Dividends are overlooked because their effect on an individual portfolio is not readily apparent unlike a change in the price of an investment. So, what role do dividends play in an investment plan?

The first is income. Many companies have a long history of paying their stockholders dividends. For many individuals, but especially retirees, they are a source of income. When creating a dividend income stream, it important to devise a portfolio consisting of stocks of profitable companies with a history of paying, as well as, increasing dividends. It is also essential to choose stocks that pay dividends during different months so there is monthly income. For example, you could build an income stream using Philip Morris (PM), General Dynamics (GD), and Exxon Mobil (XOM).  

Stock	Month Dividend is Paid
Philip Morris (PM)	January, April, July, October
General Dynamics (GD)	February, May, August, November
Exxon Mobil (XOM)	March, June, September, December

(This chart is for illustrative purposes and does not constitute a recommendation.)

Notice how the stocks work together to provide a steady stream of dividend income.  They pay in different months throughout the year and there are no gaps. Keep in mind a sufficient amount of money is required for individual stocks to create a desired income. A portfolio of mutual funds and exchange-traded funds invested in these companies can also provide dividends. Funds with terms like high-dividend, growth and income, and equity-income in their names are examples. Make sure you read the funds information sheet and prospectus for guidance.

Dividends are a useful tool to build wealth.  Just about every investment company allow clients to reinvest dividends back into the stocks, mutual funds, and exchange-traded funds inside their accounts. When these dividends are reinvested, more shares are purchased.  This is called a Dividend Reinvestment Plan (DRIP).  For example, a company, ABC Inc’s, stock is valued at $10 per share. ABC Inc declares a dividend of one dollar per share. A DRIP participant holding 100 shares will receive 10 shares of company stock (100 shares/$10 per share = 10 shares).  These reinvested shares have increased the value of this holding.  Before the dividend was paid out, ABC Inc’s holding was worth $1000 (100 shares x $10 per share).  After the dividend was reinvested, ABC, Inc’s holding is now worth $1100. (110 shares x $10 per share). By reinvesting the dividend, ABC, Inc’s value increased by $100.*    

* This example is for illustrative purposes only.  Results may vary. Reinvesting dividends do not guarantee an increase in value.

Finally, dividends can offset declines in the value of a portfolio during market declines. Whether a dividend is reinvested or taken as income, it first passes through an investor’s portfolio and counts towards the value of the account. In the example below, a hypothetical client statement for the month has this information on the first page.

Opening Value	$1000.00
Cash Deposited	$0.00
Investment Value Change	-$100.00
Dividends Paid	$200.00
Closing Value	$1100.00

(This example is for illustrative purposes only.  Results may vary.)

The dividends in this example proved to be significant. Notice the value of the combined investments declined $100.  Yet, the closing value was $1100.00.  The $200 worth of dividends offset the investment drop and created a gain in the value of the account for the month.  Unfortunately, this example is not always the case.  However, even if the investments had dropped $300, the $200 dividend payment would have resulted in a $900 closing value. Think what would have happened without the dividends?

Dividends serve many roles for an investor whether it be income, wealth building, or providing a cushion for a portfolio during market declines.  There is one detail to keep in mind about dividends.  They are taxed as income unless paid inside a retirement or other tax-exempt account.  It important to discuss the potential tax implications of any dividend strategy with an investment advisor and tax professional.

Matt Dressel is the Owner of the Independent Financial Solutions Group, a Registered Investment Advisor. He is an Investment Advisor, Life Insurance Agent and does Financial Planning.  If you have any questions about this article, he can be reached at 252-515-0242 or matthewdressel.ifsg@gmail.com.