How does a buy-sell agreement typically use life insurance?

A buy-sell agreement is a legally binding contract that outlines how a business will process the transfer of ownership when an owner passes away, becomes incapacitated, or decides to leave the business for other reasons. Life insurance is commonly used in this context to ensure that there are sufficient funds available to buy out the deceased partner's share of the business.

When a partner dies, the life insurance policy pays out a predetermined amount to the surviving partners or the business, allowing them to purchase the deceased partner's interest at a fair market value. This ensures a smooth transition of ownership and helps maintain business continuity without financial strain on the remaining partners. The use of life insurance for this purpose is integral as it provides immediate liquidity, which would not be readily available if partners needed to sell other assets or take out loans.

The other options listed do not accurately reflect the primary function of a buy-sell agreement in conjunction with life insurance. Retirement plans, paying off debts, and profit distribution are unrelated to the specific goal of ensuring a partner's organized exit from the business through a buy-sell agreement.