Buy-sell and key-person coverage: funding the moment an owner leaves

When an owner leaves, the business should not leave with them

A business with more than one owner needs written terms for death, disability, retirement, and other departures. Insurance may fund some obligations, but the agreement, valuation method, ownership, beneficiaries, and policy design have to work together.

The planning gap is wide

A succession plan can name a buyer and a price without supplying the cash needed at death or disability. Review the agreement, valuation method, ownership, beneficiary designations, and funding together. A gap in any one of them can change the result.

How a buy-sell agreement works

A buy-sell agreement can govern what happens to an owner's interest after stated triggering events. The events and remedies come from the agreement and applicable law, so counsel should define them rather than rely on a mnemonic.

There are three main structures. In a cross-purchase, the surviving owners personally buy the departing owner's interest, each holding life insurance on the others. An entity or stock redemption agreement flips that: the business owns the policies and buys back the shares. A wait-and-see hybrid gives the business a first right of refusal before the surviving owners step in.

Cross-purchase and redemption structures can produce different ownership, basis, valuation, and tax results. Entity type, purchase terms, funding, and later law changes matter. Tax and legal counsel should model the proposed structure.

The Connelly decision changed the math on redemption agreements

In June 2024, the Supreme Court ruled unanimously in Connelly v. United States that life insurance proceeds a corporation receives to fund a share redemption increase the corporation's value for federal estate tax purposes, and the redemption obligation itself does not offset that increase. Entity-redemption agreements funded with corporate-owned coverage should be reviewed with tax and legal counsel in light of that holding.

A redemption structure that worked cleanly before Connelly may now generate an unexpected estate tax exposure. The federal basic exclusion is $15 million per individual in 2026, and the reduction that earlier planning assumed would arrive after 2025 did not take effect. The exposure now sits on the valuation side. Proceeds that fund a redemption can raise the company's reported value, and with it the value of a deceased owner's interest, above what a pre-Connelly appraisal would have shown. The case also shows why valuation language and the funding arrangement need to be reviewed together. An outdated agreement can create a different result from the one the owners intended.

Funding the agreement with life and disability coverage

Life insurance can create the liquidity a buy-sell agreement needs. In a redemption structure, the business owns the policies and is the beneficiary. In a cross-purchase, each owner holds policies on the others. Either way, the face amount should track the purchase price written into the agreement, which means the insurance and the valuation need review together whenever the business changes materially.

Permanent life insurance can serve an added purpose. Accumulated cash value may help fund a buyout at retirement, when no death benefit is triggered.

A buy-sell agreement may also define disability as a triggering event. Disability buyout coverage can fund some or all of that obligation when the policy's definition and waiting period are met.

Key-person coverage is a separate tool

Key-person insurance is distinct from buy-sell funding. The business owns a policy on an individual whose loss would significantly damage the company's finances, whether a founder, a lead salesperson, or a technical specialist. The business is both owner and beneficiary, and the proceeds can offset lost revenue or fund the cost of finding and training a replacement. Coverage sizing is not standardized across carriers, but it typically reflects the person's salary, their share of revenue, or a multiple of projected profit contribution. That figure should be revisited when the business grows or the person's role expands.

Employer-owned life insurance can be subject to IRC Section 101(j) notice, consent, insured-status, and reporting rules. When those rules apply, Form 8925 is generally used for annual reporting. Confirm the policy, insured, timing, and exceptions with tax and legal counsel before issue.

Where this fits in the financial plan

Buy-sell and key-person coverage address a specific risk that many owners overlook: the possibility that one person's exit ends what many people worked to build. They function as financial planning instruments, not products bolted onto a business problem. An independent advisor can help owners evaluate which agreement structure may suit current tax law, review existing agreements against the implications of Connelly, and keep the coverage amount aligned with actual business value over time.

This article is general information, not financial, tax, or legal advice. Coverage, tax treatment, and suitability depend on your specific situation and should be reviewed with your advisor and tax counsel.