“Do you plan to ask a young chiropractor to ‘buy-in’ to your practice as an associate some day? Would you like to enjoy retirement without too many financial pressures? Are you interested in ensuring your family’s future in case you die an untimely death?” asks John W. Gay II.
If your answer to these questions is “yes,” then maybe you can use a somewhat complex but useful technique that I often prescribe for my chiropractic clients.
The technique, which involves a life insurance policy and a buy-out method called a “cross buy-sell” offers a number of advantages for doctors:
- It helps solo doctors make their practices more attractive to the young chiropractor seeking a buy-in.
- It ensures that your practice will sell for a fair value, even if you die prematurely.
- Your family will not have to pay taxes on the proceeds.
- And, if all goes as planned, it will ease your retirement. You’ll be able to live comfortably from the proceeds of your practice sale, knowing your family will receive an equally generous amount after you die.
Typical buy-out methods don’t accomplish half this much. Methods that require the buyer and seller to take out insurance policies on each other’s lives are too expensive for the junior chiropractor; premiums for older individuals can be very high. Methods that involve transferring the stock of incorporated practices result in messy capital gains taxes.
The cross buy-sell avoids these complications. The owning chiropractor takes out a life insurance policy on his own life. He pays it off as quickly as possible so its value can begin to increase.
After the policy is paid off, the seller recoups what he paid in premiums by extracting the policy’s “cash value.” He or she signs over the remainder of the policy, called the “death benefit,” to the incoming doctor.
The effect? When the senior doctor dies, the junior chiropractor receives a death benefittax freehe can use to pay the senior doctor’s family for the practice.
Why should you buy a life insurance policy that will benefit your associate? Because it helps you even more. Without a policy, you may some day have to sell your practice at a discount because no one can afford it. Worse yet, you may never sell it at all.
But with insurance, you’ll attract a talented associate who knows he’ll have a chance to own your practice. If your associate still owes on the practice when you die, the policy will ensure that your family gets the balance. And if your associate finishes buying in before you die, your family will be doubly secure; they’ll get both the associate’s payments and the insurance benefit. You really can’t lose.
Keeping in mind that you’ll need a competent professional to evaluate your particular situation and guide you through the paperwork, read on for details.
SECURE A POLICY
First, you’ll need to purchase a life insurance policy from a reputable insurance company. Work with a professional who understands the benefits of the many policies on the market and has previously insured doctors’ practices.
Next, decide on a type of policy. Your two main options are whole life and term insurance. Term insurance is cheaper. However, if you stop paying your premium at any time, the policy’s death benefit is null and void.
Whole life costs more, but its death benefit lasts forever. The policy also builds “cash value” over the years. Since the death benefit is the cornerstone of a cross buy-sell, I recommend that you purchase whole life insurance. Once you pay off your policy, nothing can nullify that death benefit. If you choose term insurance nevertheless, get a policy that’s convertible to whole life so you can eventually pay off the policy.
How much insurance should you purchase? As a general rule, you will need enough to cover your practice’s selling price. (Some other factors figure in, and we’ll discuss them later.)
When should you buy? Consider investing in life insurance for an eventual buy-out while you’re young. You will pay significantly less than an older individual to get the same death benefit.
For example, say your practice is worth $500,000. You purchase a policy with a $500,000 death benefit. For $500,000 of whole life insurance, a 30-year-old will pay about $44,550 over the course of 10 years. A 50-year-old will pay $114,450 within 10 years.
On top of that, the policy’s death benefit and cash value will have more time to grow when you buy early (See Table One). And you always have the option of adding more insurance later. (In fact, if your practice’s value increases substantially, you’ll need more insurance to cover the inflated sale price.)
After you decide on the amount of insurance, you must choose a payment method. When it is financially feasible, I advise my clients to “lump dump” their funds, after meeting the IRS seven year pay rule, into the life insurance policy; this allows faster growth within the policy.
Why? The cash value on the paid-up policy immediately begins growing at 6 to 14 percent interest (depending on the policy type). The death benefit increases as well. In addition, full coverage begins immediately.
In contrast, a doctor who pays monthly premiums until policy is paid instead of quarterly premiums with lump dumping after seven years, will see a slower build-up of cash value and death benefit. Interest, however, will accumulate on the value of premiums paid so far but not as rapidly as on a lump dumped paid-up policy.
Nevertheless, paying by installments is more affordable for doctors who don’t have a large amount of liquid cash for a lump dump. It is also better for doctors who own practices that are worth more than they can afford to insuresay more than $500,000. In these cases, many doctors spread their payments out over seven to fifteen years.
However, if you choose installment payments, your insurance company will charge you for the extra paperwork involved in regular billing. For that reason, semi-annual payments are a bit cheaper in the long run than monthly or quarterly payments.
Most policies are flexible; you can choose your payment period. Just remember that the faster you pay off the policy, the quicker it begins to build value. A qualified professional with wide knowledge of the insurance field can help you weigh these financial factors and your particular needs.
BUY-OUT TIME
Now let’s jump ahead a few years. You have a paid-up policy with a death benefit worth $500,000-the value of your practice. Your associate expresses interest in taking over the practice after you retire, and you agree to a buy-out.
The first thing you should do is strip out the policy’s cash value. In dollar terms, that means you get back the money you put toward premiums, plus interest. Let’s say the policy’s death benefit is worth $500,000 and the cash value is $50,000. After your professional completes this transaction for you, you will have:
- $50,000 in cash (tax free), and
- A policy that pays your beneficiary a $450,000 death benefit when you die.
At the same time, work with an attorney to write a buy-out agreement that immediately transfers the death benefit to your buying associate for a token price between $1 and $100. This transfer makes your associate the owner and beneficiary of a policy that would pay $450,000 upon your death.
The contract must also include a couple of clauses to protect you and your family. The first clause stipulates that if you die before the buy-out is complete, the junior chiropractor must pay that money to your estatee.g., your family-to cover the purchase price of the practice. He cannot take the money, walk down the street, and start a new practice. He is obligated to continue yours.
The second clause stipulates that after the junior chiropractor pays off the balance due the practice, he must then transfer the policy back into the senior’s ownership, again for the token sum. The senior can then use the policy for personal benefit. Perhaps he’ll name family members as beneficiaries. They can live on the death benefit or use it to pay estate taxes after the then policy owner dies. Or, the senior doctor can borrow out the policy’s additional cash value for tax-free retirement income. He’ll come out better than he would with most retirement plans which provide tax-deferred (not tax-free) funds. That’s part of the beauty of this insurance. You can use it for a tax-free cross buy-sell. But if that’s not necessary, the policy functions just like conventional life insurance.
VARIATIONS OF A CROSS BUY-SELL
As mentioned before, a cross buy-sell can work in a number of ways. Now that you understand the basic method, I’d like to give you three variations:
Two-partner buy-out.
Some doctors will need to do a number of cross buy-sells-one for each associate who wishes to buy in. The system works the same, with one exception: you’ll need a separate death benefit for each associate.
Suppose two associates each want to buy half of your $500,000 practice. You may wish to buy a policy with a $500,000 death benefit and split it, or buy two policies with $250,000 death benefits. In either case, each associate will receive a $250,000 death benefitenough to pay for his 50 percent interest in your practice.
Part business, part pleasure.
Another option is to use one policy for two purposes: a cross buy-sell and personal security. Again, you can accomplish this by dividing the policy in half. Sign over one portion to your associate for the eventual cross buy-sell; but keep the other half, making a family member the beneficiary.
Financial Constraints
You may also choose to fund only part of the practice price through a cross buy-sell. Perhaps your practice is worth $500,000 but you can’t afford insurance with a $500,000 death benefit. In this case, you can still make out by insuring half the practice’s value. The death benefit won’t pay the whole practice sale price, but it will give your associate majority interest in the practice after you die. He can slowly pay off the remainder in cash. And, you have the option of paying extra premiums when you can afford them to increase the death benefit.
The bottom line in these three examples? The size of the policy you need, while based on the value of your practice, also depends on how you plan to use the cross buy-sell. Your professional can help you settle on a death benefit that is large enough to fund the type of buyout you desire.
In any well-structured cross buy-sell, everybody ends up winning: the senior chiropractor has sold his practice to someone he trusts; his family is justly compensated for the sale and, the junior chiropractor gets a fair, affordable shot at practicing the art of chiropractic.
John W. Gay II, LLD, RFC, CIS, President of the Denver-based consulting firm of John Gay & Associates, has assisted more than 2,600 medical professionals with the management of their practices for over 16 years. Dr. Gay, a Registered Financial Consultant, a Certified Investment Specialist, and author in many professional journals may be contacted by calling John Gay & Associates, 303-690-2727.
