Buy-sell funding when partners differ in age, health and share

Textbook buy-sell examples feature two healthy partners of the same age with equal shares. Real partnerships rarely look like that. One owner has a medical history that makes coverage hard to get, another is twenty years older than the rest, a fifth owner joins and the policy count explodes, or the shares are 60, 25 and 15 percent. This post works through four hypothetical partnerships, with the arithmetic, to show how the number of policies, the owner of each policy and the choice between a cross-purchase and an entity redemption move with the facts.

Every name and figure is invented for illustration. None is a premium quote, a recommendation of a structure or tax advice. For the basic structures, see funding a buy-sell agreement with life insurance and cross-purchase vs entity-redemption buy-sell plans.

What changes when partners are not alike

A buy-sell funding plan answers three questions for each owner: who will pay the family if this owner dies, with what money, and who bears the cost of the insurance meanwhile. When partners are identical, the answers are symmetrical and easy. Differences break the symmetry in four ways:

• Insurability. Someone who cannot qualify for standard coverage cannot be insured on the usual terms, so the plan has a hole.
• Age. The price of insuring an older partner is much higher than for a younger one. Someone pays the difference.
• Number of owners. Policy counts in a cross-purchase grow with the square of the number of owners.
• Unequal shares. The amount of insurance on each owner and the share each survivor buys must be tracked by percentage.

Each scenario below isolates one of these and shows how partners commonly adjust. In each, assume the agreement is mandatory, so the survivors must buy and the estate must sell.

Scenario 1: One partner cannot get coverage

The facts. Two partners, Nadia, age 49, and Owen, age 52, each own 50 percent of a veterinary clinic valued at $2,000,000 under their agreement. Each share is worth $1,000,000. Nadia is in good health and can buy standard term insurance. Owen has a serious cardiac condition, and insurers have declined him or quoted a price he cannot afford.

What a cross-purchase can do. Owen can buy a $1,000,000 policy on Nadia. If Nadia dies, Owen collects and buys her half. In the other direction, Nadia cannot buy a policy on Owen at a price that makes sense, so if Owen dies, there is no insurance to buy his share.

The options for Owen's side:

1. Look again at rated coverage. An insurer may offer a policy with a table rating, which adds a surcharge for higher risk. The price rises, but a rated policy may still be available. A broker who works with several insurers can ask more than one, since underwriting standards differ. Owen should apply honestly; misstatements can lead to a denied claim later.
2. Smaller or simplified coverage. guaranteed issue coverage, with no health questions, exists at small face amounts and usually with a waiting period before it pays full benefits. It is unlikely to approach $1,000,000. The guide on guaranteed issue life insurance: no health questions, with limits explains the limits.
3. Group coverage through an employer or association. If a group plan has a guaranteed amount, it may help in part. Group coverage typically ends when employment or membership ends, so it is a weak anchor for a long-term buyout.
4. A sinking fund. The company or Nadia saves a set amount each year in a reserve, and the agreement covers the rest by installment note.
5. An installment note. If Owen dies, Nadia buys his half over several years from the clinic's income. For example, a five-year note on $1,000,000 means $1,000,000 ÷ 5 = $200,000 of principal a year plus interest, and the clinic must produce that cash flow on top of its ordinary expenses.

The fairness problem. If Nadia dies, her family receives $1,000,000 in cash from Owen's policy. If Owen dies, his family receives the same price but spread over five years, and Nadia must carry the debt while she also runs the clinic. The two families are not equally protected, and Nadia bears the risk that the clinic cannot cover the note. Partners often adjust by lowering the price for Owen's share, adding a discount, or giving Nadia the right to pay with a longer note. Whatever they choose, they should decide it consciously and put it in the agreement.

What the decision looks like. Nadia and Owen agree that Owen will buy $1,000,000 of coverage on Nadia. For Owen's death, they set a five-year installment note, with a lender's commitment for a line of credit to cover the first-year payment, and they ask a broker to seek a rated policy on Owen every two years in case his condition improves or the market changes. They also write that if a policy becomes available, the clinic will pay half of its cost.

Scenario 2: A wide age gap

The facts. Two partners, Tomas, 34, and Walter, 58, own 50 percent each of a machine shop valued at $2,400,000. Each share is $1,200,000. They plan a cross-purchase with 20-year term policies.

The cost problem. In a cross-purchase, Tomas owns the policy on Walter, and Walter owns the policy on Tomas. A $1,200,000 policy on a 58-year-old costs far more than the same policy on a 34-year-old, and Tomas, the younger partner, pays the larger bill. For illustration only, suppose the annual premium on Walter is $9,000 and on Tomas is $1,800. These figures are invented, not market prices.

The entity plan splits the $10,800 evenly because each of the two equal owners bears half the company's cost: $10,800 ÷ 2 = $5,400. To get the same fairness in a cross-purchase, Walter would pay Tomas the difference. Tomas pays $9,000 but should bear only $5,400, so he should be reimbursed $9,000 − $5,400 = $3,600. Walter pays $1,800 but should bear $5,400, so he owes $5,400 − $1,800 = $3,600. The two numbers agree, as they must.

The catches. An equalizing payment from one partner to another is not obviously deductible and might be treated as compensation or something else, so the tax handling should be reviewed. A company-paid premium is typically paid from after-tax profits, because premiums are generally not deductible when the payer is a beneficiary.

The term problem. A 20-year term bought at 58 expires at 78. If Walter plans to be an active owner until 70 and then stay as a minority holder, the buyout may be needed after the term expires. Walter's policy on Tomas expires when Tomas is 54, yet Tomas may be an owner for decades after that. The two term lengths should not simply match; they should fit the horizon for each insured. They should also ask about the conversion privilege on each policy, since converting later does not require new proof of health.

What the decision looks like. Tomas and Walter choose an entity redemption for now because it equalizes cost without side payments. They note the estate tax trade-off in Connelly v. United States (June 2024), under which a company's life insurance proceeds can raise its value for federal estate tax. The federal basic exclusion is $15,000,000 per person in 2026. If neither partner's estate is near that level and their state has no lower threshold, they can accept the trade-off, and revisit annually in case their holdings or state tax rules change.

Scenario 3: Five owners

The facts. Five physicians, all in their 40s, own a medical practice valued at $5,000,000, so each owns 20 percent, worth $1,000,000. They have been planning a cross-purchase because the practice prefers that creditors cannot reach the policies.

The arithmetic. Each owner would buy a policy on each of the other four, so the number of policies is 5 × 4 = 20. Each owner pays four premiums and tracks four policies.

Now suppose a sixth physician joins as a 1/6 partner. The group needs 6 × 5 = 30 policies. The difference is 30 − 20 = 10 new policies: five on the newcomer, one owned by each existing partner, and five on the existing partners, owned by the newcomer. Every other policy must also be revisited because the shares fall from $1,000,000 to a sixth of the practice value. If the practice is still worth $5,000,000, a sixth is about $833,333, so existing policies are now larger than needed on the old partners, and the newcomer may need new coverage.

The alternatives.

• Entity redemption. The practice owns five policies. Adding a sixth partner adds one. Maintenance is simple.
• A trusteed cross-purchase or insurance LLC. A trust or LLC owns one policy on each owner and uses the proceeds to buy the deceased's share for the survivors. Policy count stays at five, and the proceeds are outside the practice. It adds an entity to set up, run and pay for, and its tax treatment needs careful review.
• Wait-and-see. The agreement lets the parties choose after a death whether the practice or the survivors buy, giving flexibility but more complexity.

What the decision looks like. The physicians value protection from the practice's creditors but dislike twenty policies. They choose the trust-owned structure with five policies and ask their lawyer to confirm how it interacts with the the transfer-for-value rule when a physician joins or leaves. The cost of the trustee and legal drafting is a small percentage of the premiums they would otherwise pay on duplicative coverage.

Scenario 4: Unequal shares

The facts. Three owners hold a landscaping company valued at $4,000,000. Ava owns 60 percent, Ben owns 25 percent and Chloe owns 15 percent. The agreement requires survivors to buy a deceased owner's shares in proportion to the shares they already own.

Values.

• Ava's stake: 60% × $4,000,000 = $2,400,000
• Ben's stake: 25% × $4,000,000 = $1,000,000
• Chloe's stake: 15% × $4,000,000 = $600,000

Who buys what under a cross-purchase.

If Ava dies, Ben and Chloe buy her $2,400,000 stake in proportion to their holdings of 25 and 15. Together they hold 40 points. Ben buys 25/40 = 62.5 percent of $2,400,000 = $1,500,000. Chloe buys 15/40 = 37.5 percent = $900,000. The two add to $2,400,000.

If Ben dies, Ava and Chloe buy his $1,000,000 in proportion to 60 and 15, which sum to 75. Ava buys 60/75 = 80 percent = $800,000. Chloe buys 20 percent = $200,000.

If Chloe dies, Ava and Ben buy her $600,000 in proportion to 60 and 25, which sum to 85. Ava buys 60/85 of $600,000, about $423,529. Ben buys 25/85, about $176,471. Rounding to $425,000 and $175,000 gives $600,000 in total.

The policies are therefore:

Six policies, six different face amounts. The amounts are tied to the percentages, so if Ava sells Chloe five points, the table changes: Ava 55, Ben 25 and Chloe 20. Every policy then needs to be recalculated. Policies are usually not easy to resize, so a plan built on exact proportions is brittle. A practical answer is to buy round amounts that meet the largest likely need and use a note for adjustments.

Premium fairness. The smallest owner, Chloe, owns a $900,000 policy on Ava, which is a major cost relative to her stake, and her health and age may differ from Ava's. Ava owns the policy on Chloe for only $425,000. Different ages and sizes may mean owners pay very different premiums, and the minority owner may be priced out.

How redemption looks. The company owns three policies: $2,400,000 on Ava, $1,000,000 on Ben and $600,000 on Chloe. After a redemption, the remaining owners' percentages rise in proportion automatically. The premium cost is shared by percentage. Chloe, with 15 percent, bears 15 percent of the cost of Ava's large policy through the company, which may be fairer than paying for it outright. The tax issues from Connelly (proceeds raising company value for estate tax) apply to the redemption structure; see cross-purchase vs entity-redemption buy-sell plans.

What the decision looks like. The three choose an entity plan, with the agreement requiring an annual update of the face amounts to track their percentages, and a clause that a buyer who lacks funds can use a note.

When two of these situations overlap

Real partnerships often combine them. A five-owner group may include one partner who is rated, and a younger partner who joined later with a smaller share. The same tools apply in combination: an entity or trust to hold the policy count down, a written method for sharing premiums, a note as the fallback for any owner who cannot be insured, and a schedule for updating amounts when percentages move.

Two habits help in every combination. Ask for quotes on several face amounts and term lengths, not one, so the partners can see how cost changes with the choice. And decide in advance, in the agreement, what happens when an insured partner's health changes: who may buy more coverage, who pays and whether the other partners must cooperate with the exam. A partner who refuses to sit for an exam can stall a plan as effectively as a health problem.

Patterns across the four scenarios

Two things hold in all four. First, the agreement should say what happens if insurance cannot be obtained or is not in force, usually through an installment note. Second, a plan that fits today needs annual maintenance; see what to check and when in a buy-sell agreement's yearly review for a review calendar.

Questions to take to your attorney and adviser

• Which structure fits our number of owners, ages and entity type?
• If a partner is uninsurable or rated, how does the agreement fill the gap fairly?
• How are premiums shared when ages differ, and how are any side payments taxed?
• What happens to the policies if shares change or a partner leaves? For the departure side, see the traps owners miss with company-owned buy-sell policies.
• How often do we update face amounts, and who is responsible?

Key takeaways

• When partners are unlike, the textbook structure bends: insurability, age, number of owners and share size each change the right design.
• An uninsurable partner leaves a hole that must be filled with rated coverage, a note, a reserve or an agreed price adjustment, and the choice should be written down.
• A wide age gap makes cross-purchase premiums lopsided: in the example $9,000 against $1,800, which an equalizing payment of $3,600 or an entity plan evens out.
• Cross-purchase policy counts follow n × (n − 1), which is why five owners need 20 policies and six need 30; entity or trust ownership holds it to one policy per owner.
• With unequal shares, face amounts follow percentages and must be revisited whenever shares move.