What happens to the death benefit from a life insurance policy used to fund a buy-sell agreement?

The death benefit from a life insurance policy used to fund a buy-sell agreement should not be included in the gross estate of the deceased if certain conditions are met. This is because the policy is often owned by a trust or another party rather than the insured individual, which helps to remove the death benefit from the taxable estate.

In buy-sell agreements, life insurance is commonly used to ensure that sufficient funds are available for the purchasing entity (often a business) to buy out the deceased owner’s interest in the business. If the policy is structured correctly, ownership and beneficiary designations are set so that the death benefit does not contribute to the overall taxable estate, thus preserving more wealth for beneficiaries and providing liquidity for the business.

Certain nuances in estate planning can affect this outcome. For instance, if the decedent had incidents of ownership in the policy at the time of death, then the proceeds might be included in the gross estate. However, if structured properly (such as through an irrevocable life insurance trust), the death benefit remains outside the estate, thereby addressing potential estate tax issues effectively.