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Entity redemption buy-sell arrangement

Why choose an entity redemption buy-sell arrangement?

If your client’s business partner died tomorrow, they could be faced with a possible downturn of revenue, possible diminished marketability and a new business relationship with their business partner’s family.

Your client may need a large quantity of money in a short amount of time in this scenario. With an entity redemption buy-sell arrangement funded through life insurance policies, your client’s company could have an asset at its disposal to help buy out their partner’s family.

An entity redemption buy-sell arrangement is a business succession strategy in which the business is the owner and beneficiary of a life insurance policy on each business owner’s life.

Upon death, the business uses the death benefit proceeds to purchase the deceased owner’s share.

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The opportunity

This strategy can:

  • Ensure business continuity and maintain marketability in the event of an owner’s death
  • Guarantee a buyer for their share of a business
  • Create liquidity for a deceased owner’s family
  • Avoid conflict of interest between surviving owners and the family of a deceased owner
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Two valuable features

  • Simplifies a buy-sell arrangement for multiple business owners
  • Provides a source of funds for the purchase of a partner’s share of the business upon certain life events
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Target client

Businesses with the following characteristics:

  • More than two or three owners
  • May be organized as an S corporation, C corporation, LLC or partnership

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When to use a cross purchase or entity redemption strategy

There are multiple considerations when selecting a buy-sell strategy suitable for a business owned by three or more people.

Learn when to use each

How it works

1. Multiple owners of a business enter into an agreement (prepared by an attorney) that should any owner die, the business will purchase the shares from that owner’s heirs.

2. The business purchases a life insurance policy on each owner, which will serve as the source of funds the business will use to redeem the deceased owner’s shares. The business is the owner and beneficiary of all the policies.

Entity redemption policies buy sell lg

3. When Owner A dies, the business receives the death benefit from A’s policy income tax-free.¹

4. The business purchases the shares from Owner A’s heirs with the policy’s death benefit, and retires them.

Entity redemption benefit buy sell lg

The subsequent decrease in the number of outstanding shares increases the value of the shares for the surviving owners. Owners B and C now each own 50 percent of the business, and Owner A’s estate has cash from the sale of the business interest.

Entity redemption buy-sell benefits and considerations


  • Works well with three or more owners of a business
  • Requires only one policy per owner
  • Total premium payments can be equalized among owners
  • Not subject to personal creditors
  • Allows business to own and control the life insurance policies funding the agreement
  • Easier to administer policy transfer upon unwinding the business


  • Does not increase basis for surviving owners of a C corporation
  • Not safe from corporate creditors
  • Owner retirement benefits are taxable if a cash value life insurance policy is used
  • Employer-owned life insurance (EOLI) written notice and consent rules apply
  • Health of owners could affect insurability
  • Premiums are not income tax-deductible by the business

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Key resources

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1. The life insurance death benefit is income tax-free to the business if the business, at the time of purchase, had met the requirements of Internal Revenue Code Section 101(j). This includes providing the insured with advance notice, obtaining the insured’s prior consent to be insured and meeting the insured’s executive income requirements.

Life insurance products contain fees, such as mortality and expense charges, (which may increase over time) and may contain restrictions, such as surrender periods.

Please keep in mind that the primary reason for purchasing life insurance is the death benefit.

Additional agreements may be available. Agreements may be subject to additional costs and restrictions. Agreements may not be available in all states or may exist under a different name in various states and may not be available in combination with other agreements.

Policy loans and withdrawals may create an adverse tax result in the event of lapse or policy surrender and will reduce both the surrender value and death benefit. Withdrawals may be subject to taxation within the first fifteen years of the contract. Clients should consult their tax advisor when considering taking a policy loan or withdrawal.

The Policy Design chosen may impact the tax status of the policy. If too much premium is paid, the policy could become a modified endowment contract (MEC). Distributions from a MEC may be taxable and if the taxpayer is under the age of 59 ½ may also be subject to an additional 10% penalty tax.    

An annuity is intended to be a long-term, tax-deferred retirement vehicle. Earnings are taxable as ordinary income when distributed, and if withdrawn before age 59½, may be subject to a 10% federal tax penalty. If the annuity will fund an IRA or other tax qualified plan, the tax deferral feature offers no additional value. Qualified distributions from a Roth IRA are generally excluded from gross income, but taxes and penalties may apply to non-qualified distributions. Please consult a tax advisor for specific information. There are charges and expenses associated with annuities, such as surrender charges (deferred sales charges) for early withdrawals.

This information may contain a general discussion of the relevant federal tax laws. It is not intended for, nor can it be used by any taxpayer for the purpose of avoiding federal tax penalties. This information is provided to support the promotion or marketing of ideas that may benefit a taxpayer. Taxpayers should seek the advice of their own tax and legal advisors regarding any tax and legal issues applicable to their specific circumstances.

For financial professional use only. Not for use with the public. This material may not be reproduced in any form where it is accessible to the general public.

DOFU 10-2022