How to Insure Your Income: Funding a Disability Buyout
Where will the money come from to complete the disability buyout? And will the disabled stockholder have adequate family income during the elimination period?
The answer to both questions can come from disability income insurance. A disability income policy also will answer other questions that often occur in stressful circumstances:
- What is the exact sum of money that will be available?
- Will it be there when we need it?
- Who will define when an owner is totally disabled?
- What tax implications will follow any buy-sell deal?
Usually, the business is the owner and premium payor for the policy or policies. The premiums are not deductible, but the benefits received by the business are tax-free.
The amount necessary to complete the buyout will be delivered exactly when needed, due to the filing of the disability claim. In addition, the policy's elimination period normally will correspond to the waiting period in the agreement. Thus, if the buyout is to begin one year after the onset of disability, the disability policy will be issued with a one-year elimination period.
The insurance company, in accordance with the policy's wording, will determine total disability. Total disability of an owner will, in turn, trigger the buyout.
Typically, total disability is defined as the "inability to perform the duties of one's occupation." (This is a liberal definition, though. Some policies may use a definition that's more restrictive and specific about what a person must not be able to do in order to be considered totally disabled.)
Using the policy's definition of total disability removes any doubt or argument as to the degree of disability an owner has suffered. Stockholders or partners do not decide when a person is disabled. The policy and the insurance company do.
Providing a funded disability buyout offers the following advantages to the remaining owners:
- it assures that the remaining stockholders maintain control of the business;
- it enables the stockholders to keep inexperienced family members of the disabled stockholder from engaging in the business;
- it guarantees that a competitor will not purchase the interest of the disabled stockholder; and
- it provides for continuity of management and business activity, which is beneficial to customers and existing employees.
The advantages of a funded disability buyout for the disabled owner include:
- the establishment of a definite market and value for his or her business interest;
- assurance that family members will not be forced into the business in order to maintain their economic welfare; and
- assurance that the buyout will only occur after an agreed-upon period of time has elapsed.
In accordance with the agreement, the buyout may consist of a lump sum settlement after the waiting period, or it may be a series of monthly installments for a period of a few years. The disability income policy's benefit period normally will match this installment provision by providing monthly benefits for a period of two, three or five years. It also may provide for a lump sum payment following the elimination period.
To accompany the general concept of the disability buy-sell, there also should be individual disability income insurance for each of the stockholders or partners. The purpose of this additional contract is to provide monthly income to the disabled stockholder. This relieves the corporation of any moral obligation or dilemma regarding the need to provide income to the person following the disability.
A final note: A company can buy disability insurance on any key employee -- not just owners. The benefit issues and tax issues work the same way.
