Annuity vs Life Insurance for Buy-Sell Funding

How Is Buy-Sell Funding in 2026

Buy-sell agreement funding is needed for business continuity planning. It ensures that partners can afford to buy out an owner’s interest in case of a triggering event, such as death or retirement. Insufficient funds for a buy-sell agreement can lead to the chaotic downfall of the company.

Life insurance and annuities are two common funding methods, but they work very differently. Let’s go over how life insurance and annuities work, when one is better for buy-sell funding, and mistakes to avoid.

Product Mechanics: How They Fund the Buyout

Buy-sell agreements prevent owners from selling business interests to outsiders without consent. They are mainly funded by life insurance taken out on the other partners, but annuities are also a viable (and sometimes preferred) option.

Life Insurance

Life insurance coverage provides a death benefit upon the designated person’s death (the triggering event). The benefit can go into the millions, making it easy to fund a buy-sell agreement.

The life insurance death benefit provides a large amount of immediate liquidity upon the death of a partner, unless there are suspicious or special circumstances surrounding the death. Because of the way it works, life insurance is often considered a “death-centric” product.

Life insurance for funding buyouts is primarily used for entity-purchase or cross-purchase structures. For corporation value increasing taxable value concerns, partners may need to purchase the life insurance policy instead of the corporation itself.

Tax-wise, life insurance death benefits are typically tax-free. For buy-sell agreements, a life insurance trust is usually unnecessary. Trusts are only for complex scenarios and estate tax planning concerns.

Annuities

Annuities are a financial product that provide regular, guaranteed payments to you after you make the initial investment. They may be paid out for the rest of your life, or throughout a predesignated term. It is like a guarantee for income in the future, either long-term or immediate (within a year) depending on your chosen annuity.

Generally, for buy-sell agreements, you and your business partner would own contracts on each other. All buy-sell triggering events need to be agreed upon by all partners. When a triggering event occurs, then the money from annuities can be used to purchase the partner’s business interests.

Two main types of annuities exist:

Income annuities: AKA immediate annuities, these have a minimal delay (<1 year) after you invest. Good fit for those who are almost at retirement age who require immediate income.

Deferred annuities: No immediate payout. Investment grows tax-deferred until you reach retirement, when you can make regular withdrawals. Better for younger partners and investors.

Then you also have fixed, variable, or indexed annuities. They can provide you with either predictable returns or more potential growth.

Annuities can also be used as retirement benefits for employees, offered by employers. They can be used to create a structured, long-term payout for the retiring partner. They are also used in a private annuity or deferred annuity arrangement in order to facilitate a "slow-motion" buyout.

Annuities are issued by insurance companies and purchased through a licensed expert.

Cash Flow Comparison: Premiums vs. Payouts

Life Insurance

Life insurance policies have a consistent premium cost. Unless you have a waiver of premium or other rider to modify the coverage, this life insurance premium is expected to be paid consistently during the policy term. Failure to pay the premium can lead to lapses in coverage and penalties, leaving the business without a death benefit if the covered person passes away.

Life insurance may be a strain on a growing business’s operating capital, though this of course depends on how expensive the premiums are and how much money the business is working with.

Annuities

Annuities are typically funded with a lump sum or through accumulated business earnings. It is like a personal pension. When buying annuities, how much an annuity costs depends on what kind is chosen.

Growth inside the annuity isn't taxed until distributions begin. However, annuity withdrawals are taxable. There may also be associated fees, like minor administrative fees or commission fees. For example, if you plan to pay $100,000 for an annuity, you may also need to pay an additional fee for commissions that will cost between 1 to 8 percent of this amount.

Annuities allow the business to pay for the buyout out of future earnings rather than upfront premiums. If you ever need to cancel the annuity early, there are contingent deferred sales charges or other penalties.

Tax Bracket Strategy of Annuities vs Life Insurance

Taxes, taxes, taxes. Everyone wants to see what tax strategies are safe and effective to use based on their tax bracket and situation.

The Life Insurance Advantage

Death benefits are generally income tax-free. A well-structured life insurance policy can also avoid probate and public scrutiny, allowing funds to be readily available to the beneficiary or beneficiaries.

Life insurance products are generally preferred when partners want to ensure the surviving family receives a clean and immediate lump sum of money without tax impact. Regular inheritances may be subjected to estate taxes, but the life insurance can avoid the estate tax when properly set up.

The Annuity Advantage

Annuities give you tax-deferred growth during the accumulation phase. This means that you wouldn’t need to pay any taxes on this growth unless you actually withdraw money. If you do withdraw, it may count as ordinary income and be taxed accordingly.

During the surrender period, annuities may have restrictions for early withdrawals depending on what annuities you have purchased

Those who fall under high tax brackets or retirement goals can consider the advantages of annuities.

Does Corporate Life Insurance Increase Taxable Value?

Corporate owned life insurance policies can now actually increase the taxable value of the business and the decedent’s estate, inadvertently. This follows the results of the Connelly v. United States case in the Supreme Court.

Because of this, many corporations are looking for legal workarounds. Pivoting away from entity-redemption and into cross-purchase agreements is viable, meaning that individually purchased life insurance is used instead of corporate-purchased.

Another possible workaround is to obtain a private annuity that can avert this Connelly problem, since the annuities would be used to fund the buy-sell agreement instead of a corporate-purchased life insurance policy.

The Exclusion Ratio

A portion of every annuity payment is considered a tax-free return of principal, which is highly efficient for partners in the 2026 top marginal brackets.

How to Choose the Right Product

How the buy-sell agreement gets funded is an important choice, and every partner and business’ situation should be considered when making that choice.

You have to assess your situation to see whether annuities or life insurance is better.

When life insurance is better

Life insurance is for the worst case scenarios that are eventually inevitable, yet also unpredictable. The death benefit provides a huge lump sum that can fund buy-sell agreements when the funding is needed most: upon accidental, unexpected deaths.

Life insurance can be better if the partners or owners are young, because annuities for retirement would not really apply.

If the business works in a high-risk sector, it may also use life insurance better due to the greater mortality risks. For example, construction workers are more likely to pass away abruptly, making life insurance more likely to be used.

In addition, if a primary goal is family protection in case of a tragedy that takes away the life of a partner, life insurance can be invaluable in providing quick cash to help out the surviving loved ones with urgent expenses and supporting their long-term goals.

Just be careful to structure the life insurance product properly for the buy-sell agreement. Corporations should beware the so-called Connelly problem, which could impact the company’s value for estate taxes by inflating it. Legal workarounds can be used. A financial and legal expert should be consulted for using life insurance to fund buy-sell agreements, especially under corporations.

When an annuity is better

If the partners are within 10 years of retirement or so, annuities often become much more relevant.

If the business has stable cash flow and is quite prepared to pay for annuities, then they may be more desirable than a life insurance policy on the partner.

Also, if the aim is to provide the exiting partner with a "pension-like" income, which is a common business goal, then annuities should be highly relevant and beneficial. Of course, this is on top of an actual retirement fund (e.g. 401(k)).

How Buy-Sell Agreement Type Makes a Difference

Buy-sell agreements have different triggering events.

Three buy-sell agreements types are the most common:

Cross-purchase agreements: The withdrawing (e.g. retiring or deceased) partner sells their interest to the remaining partners.

Entity-purchase agreements: The withdrawing partner sells their interest to the entity/company.

Hybrid agreements: Withdrawing partner has to offer interest ownership to entity first, then to other owners. This is the most common hybrid agreement, but other variations exist.

The type of company’s buy-sell agreement you’re trying to fund can also make a difference. For example, funding LLC buyouts versus a small business versus a large corporation can be very different.

Regardless of the type, the amount and accessibility of funds for the buy-sell agreement is typically the largest cause for concern. You want the business to be able to transition to the new ownership of interests as smoothly and easily as possible. Because of this, the funding method should be decided upon promptly as a business expands and gains new continuity goals.

Hybrid Approach

It is definitely a good idea to consider a hybrid approach if you find a single one lacking. Life insurance can feel limiting because it only pays out upon death. What if the owner decides they want to retire instead? On the other hand, accidents and tragedies happen. What if a partner who planned to retire and exit with an annuity passes away suddenly, years before expected?

A hybrid strategy combines annuities and life insurance in order to create the best of both worlds. The life insurance product can cover death-triggered buyouts, while annuities can cover planned exits and retirements. Many companies appreciate this layered approach.

Other options

Of course, life insurance and annuities are not the only ways to fund a buy-sell agreement. Many business owners also turn to:

• Business loans and other borrowing
• Selling assets directly for money
• Sinking fund
• Disability insurance
• Good old cash

Conclusion

In most cases, partners find life insurance to be the better way to fund buy-sell agreements because the main triggering event for these buy-sells is death. That is when the death benefit makes the biggest difference.

Businesses that care deeply about retirement-triggered buyouts or gradual leadership transitions can consider annuities instead (or on top of) life insurance.

In 2026, it is a good idea to consider a hybrid strategy of using term life for the sudden death risk and a private annuity for the expected retirement plan. Review the best life insurance companies for competitive life insurance policies.