The Role of Life Insurance in Business Succession Planning

As the largest intergenerational wealth transfer in history unfolds, estimated at $84 trillion over the next two decades, many high-net-worth (HNW) business owners will face the challenge of efficiently transitioning their enterprises.  Despite this impending shift, many lack formal succession plans.  According to recent Gallup research, of approximately 30 million businesses in the U.S. with no employees, only 35% plan to transfer ownership through a sale or gift, and 40% have no plan. Their findings also revealed that roughly half of the total surveyed U.S. businesses either plan to close or do not have a plan. Succession planning can ensure business continuity, safeguard family wealth, and provide clarity during times of transition. To that end, life insurance can provide tax-advantaged liquidity, support buy-sell agreements, and stabilize businesses during a pivotal leadership change.

Why Succession Planning Matters

Business succession planning puts the financial and operational structures in place for a stable transfer to the successor(s).  For many HNW families, business is both an income source and a cornerstone of the family’s legacy.  Clear succession strategies can prevent leadership vacuums (gaps in authority and effective decision-making), estate tax burdens, and legal entanglements that can threaten their long-term viability.  Life insurance can be the financial glue that holds a succession plan together.

The Strategic Value of Life Insurance

Life insurance brings several distinct advantages to business succession planning, especially for privately held enterprises with complex ownership structures or significant estate exposure:

• Immediate Liquidity: Proceeds from life insurance policies can cover estate taxes and outstanding debts. They can also buy out other stakeholders.  This liquidity can help prevent the hasty sale of business assets or borrowing under duress.
• Buy-Sell Agreement Funding:  Life insurance that funds buy-sell agreements can smooth ownership transitions if a partner dies. The surviving owners can use the death benefit to purchase the deceased owner’s share at a pre-agreed price.
• Estate Equalization: When not all heirs will inherit or manage the business, a life insurance policy can provide non-operating heirs with equivalent financial value, to help minimize family disputes and preserve company integrity.
• Key Person Protection:  Business owners or companies can take out life insurance policies on vital executives or owners to protect the organization from sudden losses, helping to fund the search for and onboarding of new leadership.

Life Insurance and The Connelly Decision

The 2024 U.S. Supreme Court decision in Connelly v. United States has reshaped how life insurance is treated in business valuations for estate tax purposes. The determination ruled that when companies use a life insurance policy to fund a buy-sell agreement, the death benefit increases the company’s fair market value and cannot be treated as an offsetting liability. The ruling resulted in the Connelly estate owing nearly $900,000 more in taxes; an incentive for business owners to review their buy-sell agreements and potentially consider other arrangements. For example, cross-purchase agreements, where individual owners rather than the business hold the life insurance, or using a separate entity like an LLC to manage policies, may help reduce exposure.

Advanced Insurance Strategies for HNW Business Owners

High-net-worth individuals can apply advanced planning methods to mitigate estate tax risk and streamline their wealth transfer, using life insurance in nuanced ways, including: 

• Private Placement Life Insurance (PPLI): PPLI allows ultra-affluent investors to place alternative investments like hedge funds or private equity inside a life insurance wrapper, deferring taxes and passing wealth income-tax-free to heirs. Premiums can be large, but the long-term tax deferral and estate planning advantages are substantial.
• Irrevocable Life Insurance Trusts (ILITs): Placing a life insurance policy inside an ILIT removes proceeds from the taxable estate. The trust can distribute funds to pay estate taxes or buy out heirs in a tax-efficient manner, to help preserve business continuity and family harmony.

Pairing these strategies with accurate business valuations and coordinated estate planning can transform life insurance from a contingency asset to a proactive legacy planning instrument.

The Importance of Professional Collaboration

To effectively integrate life insurance into a business succession strategy, HNW business owners should consult professionals across disciplines for a coordinated plan. Working in concert, estate attorneys, tax advisors, business valuation experts, and financial planners can structure policies and ownership arrangements to withstand scrutiny and fulfill long-term objectives. Evolving tax laws and family dynamics make regular reviews equally essential to the process.

Whether passing the reins to family or preparing for an eventual sale, life insurance may play a pivotal role for business owners thinking about the next chapter. For assistance with developing a succession strategy or review of an existing plan, contact a financial advisor at SHP Financial. We’ll start with a complimentary review of your finances and then work toward securing the future of your business and the well-being of those you care about most.