August 5, 2026
9:44 pm

Buy-Sell Funding After a Partner Buyout

When a partner is bought out, the life insurance that funded the buy-sell agreement usually has no remaining purpose – and the safest first move is to stop and inventory who owns which policy, because in a cross-purchase structure the departing partner may personally own a policy on someone who is still in the business. Unwinding that ownership carelessly triggers the transfer-for-value rule and turns a tax-free death benefit into taxable income.

Two structures dominate, and they unwind very differently. In an entity redemption, the company owns policies on each owner and buys back the departing owner’s interest. In a cross-purchase, each owner personally owns a policy on each of the others – which means three partners require six policies, and the paperwork is usually a mess by the time anyone reads it.

This page explains what to do with those policies now, the tax provisions that govern the unwind, and a straight comparison of keeping, reassigning, surrendering, exchanging, or selling. Pine Lake Life Solutions offers a free policy review; it is not a law firm or accounting firm and does not provide legal, tax, or investment advice. Buy-sell unwinds genuinely need your own counsel.

In This Article

First: Inventory Who Owns and Who Pays
Connelly v. United States and Why Redemption Structures Changed
The Transfer-for-Value Rule Governs the Unwind
Every Option for the Policies, Side by Side
When a Sale Is the Wrong Answer
Documenting the Unwind Properly
Getting an Objective Number and Disclosures
Frequently Asked Questions

First: Inventory Who Owns and Who Pays

Before any decision, build a one-page grid with five columns for every policy: owner, insured, beneficiary, face amount, and who actually pays the premium. In practice these four rarely line up with what the buy-sell agreement says, because ownership was set up years ago and never revisited after a partner joined, left, or changed the funding.

Then check three documents against the grid: the buy-sell agreement itself, any amendment executed as part of the buyout, and the carrier’s records. If the agreement required policies to be transferred or surrendered on a departure, that provision governs and may already be in default.

Common findings: a policy on a departed partner that the company still pays for; a policy owned by a partner who left in 2019 insuring a partner who is still active; and a beneficiary designation naming a spouse rather than the entity. Each of those is fixable, but each has a different tax consequence, which is why the inventory comes first.

Connelly v. United States and Why Redemption Structures Changed

In June 2024, the U.S. Supreme Court decided Connelly v. United States, holding unanimously that life insurance proceeds a corporation receives to fund a share redemption increase the company’s fair market value for estate tax purposes, and that the redemption obligation is not a liability offsetting those proceeds.

The practical effect is significant: in a closely held corporation using an entity redemption structure, the death benefit inflates the value of the deceased owner’s shares, which can produce an estate tax bill the family did not plan for. Many advisers responded by moving clients toward cross-purchase arrangements, insurance LLCs, or special purpose entities.

Why it matters after a buyout: if the surviving owners are rethinking the structure anyway, that is the moment to decide whether the existing policies fit the new plan or should be repositioned. Do not simply leave the old redemption policies in place because they are already paid up through the year. Confirm how Connelly applies to your entity type and valuation with your own tax counsel as of 2026.

The Transfer-for-Value Rule Governs the Unwind

IRC Section 101(a)(2) makes a death benefit taxable above the consideration paid plus subsequent premiums whenever a policy is transferred for valuable consideration – with statutory exceptions for transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, to a corporation in which the insured is a shareholder or officer, and for carryover-basis transfers.

Read that list carefully in a cross-purchase unwind. Transferring a policy from a departing shareholder to a remaining shareholder individually is not on the list. Transferring the same policy to a partnership that includes the insured, or to the insured directly, is. This is why insurance LLCs and partnership structures show up in well-drafted cross-purchase plans – they exist to keep transfers inside an exception.

The cleanest unwind is almost always to transfer each policy to the person it insures. That fits an exception, aligns economic interest with ownership, and lets each individual decide independently whether to keep, convert, or sell it. See a buy-sell policy that is no longer needed.

Policy Situation After the Buyout	Cleanest Move	Transfer-for-Value Risk	Notes
Entity owns a policy on the departed partner	Transfer to the insured, or evaluate a sale	Low if transferred to the insured	Company premium stops either way
Departed partner owns a policy on a remaining owner	Transfer to the insured	High if transferred to another owner individually	Insured then decides independently
Remaining owners still need buy-sell funding	Repurpose the existing policies	Depends on the receiving entity	Cheaper than new underwriting at older ages
Policy pledged to the buyout lender	Wait for a written release	N/A	No sale can close until released
Small policy, insured under 65 and healthy	Surrender or reduced paid-up	N/A	Secondary market interest is unlikely

The Transfer-for-Value Rule Governs the Unwind

Every Option for the Policies, Side by Side

Repurpose for the new ownership structure. If remaining owners still need buy-sell funding, existing policies on their lives may be reusable with amended ownership and beneficiary designations – far cheaper than new underwriting at older ages.

Transfer to the insured. Clean under the transfer-for-value exception; the individual takes over the premium and the decision.

Reduced paid-up. On whole life, ends the premium and preserves a smaller guaranteed benefit. See how it works.

1035 exchange. Tax-free repositioning of cash value into a contract that matches the new plan.

Surrender. Cash surrender value only; gain above basis is ordinary income to the owner.

Life settlement. A lump sum, generally 10% to 35% of face value and roughly 4 to 8 times surrender value per the federal GAO’s study (GAO-10-775), for policies of about $100,000 or more where the insured is typically 65 or older and cooperates with underwriting.

When a Sale Is the Wrong Answer

Be direct about it. If the remaining owners still need buy-sell funding, do not sell a policy insuring one of them – reissuing that coverage five or ten years later costs dramatically more, and health may have changed in the interim. Repurposing beats liquidating.

Do not sell when the insured is under 65 and healthy; life expectancy underwriting drives pricing and those policies typically draw weak offers or none at all. Do not sell a term policy whose conversion privilege has expired – there is generally nothing there. And do not sell a policy that is collaterally assigned to a lender as part of the buyout financing until that assignment is formally released; see how collateral assignments work.

A sale is worth exploring when a departed partner personally owns a large policy on a former colleague with no remaining relationship, when the entity holds coverage on someone who left years ago, or when premiums on an aging universal life contract are escalating and nobody has a use for the death benefit. See rising universal life costs.

Documenting the Unwind Properly

Whatever you choose, paper it. At minimum: a written amendment or termination of the buy-sell agreement reflecting the buyout; board or member consent authorizing the policy dispositions; a bill of sale or assignment for each policy transferred, stating the consideration; updated carrier ownership and beneficiary forms with written confirmation; and a memo from the CPA documenting the tax treatment relied upon.

If the corporation is transferring a policy to an owner, get a fair market value determination rather than defaulting to cash surrender value – the two can differ substantially, and the IRS has issued safe harbor guidance on valuing contracts in these transactions. See policy fair market value.

Finally, close the loop with the carrier. An assignment that lives only in a law firm’s file and never reaches the insurer does not change who gets paid. Request written confirmation of every ownership and beneficiary change.

Getting an Objective Number and Disclosures

If part of the unwind involves deciding whether a policy has market value, a free policy review is the quickest way to find out. It starts with the policy cover page – carrier, policy number, face amount, issue date – plus confirmation that the insured will cooperate with a HIPAA authorization. No cost, no obligation.

If a transaction proceeds, expect roughly 60 to 120 days from application to funding, with proceeds held by an independent escrow agent until the carrier records the ownership change, and a state rescission window afterward. Questions: (305) 209-7183.

Pine Lake Life Solutions provides educational information and free policy reviews only. It is not affiliated with any carrier, is not a law or accounting firm, and does not provide legal, tax, or investment advice. Buy-sell taxation, entity valuation, and the transfer-for-value exceptions are technical; confirm every point with your own advisers as of 2026.

Frequently Asked Questions

What happens to buy-sell life insurance when a partner is bought out?

Nothing automatically – the policies stay in force under their existing ownership until someone acts. The buy-sell agreement may require transfer or surrender on a departure, so read it first. Build an inventory of owner, insured, beneficiary, and premium payer before making any changes.

Can I just transfer the policy to my remaining business partner?

That is exactly the move that triggers the transfer-for-value rule under IRC Section 101(a)(2), because a transfer to a co-shareholder individually is not a statutory exception. Transfers to the insured, to a partner of the insured, or to a partnership including the insured do qualify. Have counsel structure it before signing anything.

What did Connelly v. United States change?

In 2024 the Supreme Court held unanimously that life insurance proceeds received by a corporation to fund a share redemption increase the company’s value for estate tax purposes, and the redemption obligation does not offset them. Many closely held businesses have since revisited entity redemption structures. Ask your tax counsel how it applies to your entity as of 2026.

Should we keep the policies for the remaining owners?

Often yes. Replacing coverage on owners who are now five or ten years older, possibly with new health issues, is significantly more expensive than amending ownership on policies already in force. Repurposing is usually the better economics when buy-sell funding is still needed.

Can a business sell a life insurance policy it no longer needs?

A business can generally sell a policy it owns in the secondary market, subject to its governing documents and board authority. The insured must cooperate with a HIPAA authorization and life expectancy underwriting for any offer to be made. Policies of roughly $100,000 or more with an insured typically 65 or older are the realistic candidates.

How much do policies typically bring in a sale?

The federal GAO’s market study found sellers generally received about 10% to 35% of face value, roughly 4 to 8 times cash surrender value on average. Pricing depends heavily on the insured’s age and health and the ongoing premium. A free review indicates whether a specific policy is a candidate.

What documents should we have ready?

The buy-sell agreement and any buyout amendment, current carrier statements showing ownership and cash value, in-force illustrations, and any collateral assignment filed with the insurer. Add board or member consent authorizing the disposition. Start a no-cost review with just the policy cover page.

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