Cross Purchase Plan

A Cross Purchase Plan is a life insurance strategy used among business partners. Each partner buys a life insurance policy on the other partners to ensure business continuity and facilitate buyouts in the event of a partner's death.
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A Cross Purchase Plan is a type of life insurance arrangement used primarily by business partners to ensure the continuity of their business in the event of one partner’s death. Each partner purchases a life insurance policy on the life of the other partners, ensuring that there is sufficient funding to buy out the deceased partner’s share of the business.

Examples

  1. Small Business Partnership: Imagine a small business owned by three partners—A, B, and C. Each partner purchases life insurance policies on the other two partners. If Partner B dies, the proceeds from the insurance policies purchased by Partners A and C on B’s life are used to buy B’s share of the business from B’s estate.

  2. Law Firm: In a mid-sized law firm with four partners, all partners obtain life insurance policies on each other. When one partner unexpectedly passes away, the insurance payouts allow the remaining partners to purchase the deceased partner’s interest without financial strain on the firm or their personal finances.

Frequently Asked Questions (FAQs)

1. How does a Cross Purchase Plan differ from an Entity Purchase Plan?

  • In a Cross Purchase Plan, individual partners buy insurance policies on each other. In an Entity Purchase Plan, the business entity itself buys insurance on each partner.

2. What are the tax implications of a Cross Purchase Plan?

  • The premiums are generally not tax-deductible for the payers. However, the death benefits received are typically tax-free.

3. Can a Cross Purchase Plan accommodate more than two partners?

  • Yes, though the complexity increases with more partners, as each partner must buy policies on all other partners.

4. What happens if a partner leaves the business?

  • If a partner leaves, the policies might be re-evaluated or transferred. It’s essential to have flexible policy terms.

5. Who decides the value of a partner’s share?

  • Typically, the value is agreed upon in advance and outlined in the partnership agreement, or it can be determined by a third-party appraiser.
  • Entity Purchase Plan: An arrangement where the business entity itself buys life insurance on the lives of owners, with the business as the beneficiary.
  • Buy-Sell Agreement: A binding contract outlining the procedure for one partner to buy out a withdrawing, deceased, or disabled partner’s share.
  • Key Person Insurance: Life insurance taken to compensate a business for financial losses resulting from the death of a key individual.
  • Partnership Agreement: A legal document detailing the terms of the partnership, including the distribution of profits and the management structure.

Online References

Suggested Books for Further Studies

  • “Business Succession Planning for Dummies” by Arnold Dahlke: An accessible guide to business succession planning, including insurance strategies.
  • “The Partnership Book: How to Write A Partnership Agreement” by Denis Clifford and Ralph Warner: Practical insights into structuring partnership agreements.
  • “Buy-Sell Agreements: Ticking Time Bomb or Reasonable Resolution” by L. Paul Hood Jr.: Detailed information about buy-sell agreements and life insurance role.

Fundamentals of Cross Purchase Plan: Insurance Basics Quiz

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