Financial Advisor Business Owner Financial Planning ā Questions and Answers
Question 1: A properly structured and funded buy-sell agreement accomplishes which primary outcome upon the death of a business partner?
- The surviving partners receive the deceased partner's life insurance proceeds directly as income
- The deceased partner's estate receives fair value for the business interest while surviving partners retain full control (Correct answer)
- The business automatically dissolves and assets are liquidated among all heirs
- The deceased partner's heirs automatically become equal co-owners in the business
Correct answer: The deceased partner's estate receives fair value for the business interest while surviving partners retain full control
A buy-sell agreement funded by life insurance ensures business continuity: the surviving owners (or the entity) purchase the deceased owner's interest at a predetermined or formula price, providing liquidity to the estate and preventing unwanted co-ownership with heirs. Without a funded buy-sell, heirs may be forced into an unwanted partnership or accept a distressed sale price.
Question 2: In a cross-purchase buy-sell agreement among four business partners, how many life insurance policies are required?
- 4 policies ā one per partner
- 8 policies ā two per partner
- 12 policies ā each partner insures each of the other three (Correct answer)
- 1 entity policy covering all partners
Correct answer: 12 policies ā each partner insures each of the other three
In a cross-purchase arrangement, each partner personally buys a policy on each other partner's life. With four partners: 4 Ć 3 = 12 policies. The formula is n Ć (nā1). This administrative complexity for larger groups is why entity-purchase (stock redemption) buy-sells are preferred when there are many owners.
Question 3: Which retirement plan structure allows a self-employed individual with no employees to make both an employee elective deferral AND an employer profit-sharing contribution in the same year, maximizing total contributions?
- SIMPLE IRA
- SEP-IRA
- Solo 401(k) / Individual 401(k) (Correct answer)
- Traditional defined benefit pension plan
Correct answer: Solo 401(k) / Individual 401(k)
A Solo 401(k) allows the self-employed owner to contribute as both employee (up to the elective deferral limit, $23,000 in 2024 plus catch-up if 50+) and as employer (up to 25% of compensation). This dual contribution structure allows higher totals at lower income levels than a SEP-IRA, which only allows the employer contribution (25% of net self-employment income).
Question 4: When gifting a minority interest in a family business for estate planning purposes, which valuation discount reflects the fact that the recipient cannot unilaterally direct business decisions?
- Blockage discount
- Discount for lack of marketability (DLOM)
- Minority interest discount (discount for lack of control) (Correct answer)
- Key person discount
Correct answer: Minority interest discount (discount for lack of control)
A minority interest discount (or discount for lack of control) reduces the value of a business interest that does not carry voting control. A buyer would pay less for a non-controlling stake because they cannot compel dividends, force a sale, or set business strategy. This discount is commonly stacked with a discount for lack of marketability (DLOM) to further reduce the transfer value.
Question 5: A business purchases a life insurance policy on its top sales executive, naming itself as beneficiary. The primary purpose of this arrangement is to:
- Provide a tax-free death benefit directly to the executive's family
- Fund the company's buy-sell agreement with other partners
- Protect the company financially against the economic loss caused by the executive's death (Correct answer)
- Create a supplemental retirement benefit (SERP) for the executive
Correct answer: Protect the company financially against the economic loss caused by the executive's death
Key person life insurance protects the business ā not the employee's family ā from the financial impact of losing a critical contributor: lost revenue, recruiting and training costs, loan covenant concerns, and investor confidence. The business owns the policy, pays the premiums, and receives the death benefit. Premiums are generally not deductible; proceeds are generally income-tax-free.
Question 6: A nonqualified deferred compensation (NQDC) plan differs from a qualified plan primarily because:
- Employer contributions to an NQDC plan are immediately tax-deductible
- NQDC plans must cover all employees on a nondiscriminatory basis
- The employee recognizes income when compensation is constructively received, not when earned; the employer deducts it at the same time (Correct answer)
- NQDC plans have annual contribution limits established by the IRS each year
Correct answer: The employee recognizes income when compensation is constructively received, not when earned; the employer deducts it at the same time
In a nonqualified deferred compensation arrangement, the employee defers recognizing income until actual or constructive receipt (typically at retirement or termination), and the employer takes its deduction at that same time. Unlike qualified plans, NQDCs have no IRS contribution limits, can discriminate in favor of key executives, but also carry substantial risk ā the deferred amounts are an unsecured promise of the employer.
Financial Advisor Business Owner Financial Planning
A properly structured and funded buy-sell agreement accomplishes which primary outcome upon the death of a business partner?