How to Insure Your Income: Salary Continuation Plans
Another use for disability income insurance is to fund a formal sick pay plan or salary continuation agreement.
A sick pay plan is a formal program for continuing the compensation of key employees -- including the business owner and working stockholders. The plan is usually best funded with disability insurance (individual or group disability policies may be used).
If the plan is established in accordance with Section 105 of the Internal Revenue Code, it has certain tax advantages. For a sick pay plan to be valid -- and thus tax-deductible to the corporation -- it must be:
- effective before the disability commences;
- formalized in writing; and
- communicated (in writing) to the employees.
Non-compliance with the IRS requirements will cost the corporation the tax deduction.
When a key person becomes disabled, it is too late to install a plan. If money is paid to a disabled owner due to the implementation of a sick pay plan after the owner has became disabled, it is treated as a dividend -- and not a disability income benefit.
By establishing a formal plan in accordance with IRS Code, any payments made are necessary business expenses. If the company funds the sick pay plan with disability income contracts, the premiums paid are tax-deductible to the corporation (though they will be taxable to employees -- as sick pay usually is).
It also should be noted that sick pay benefits are subject to Social Security taxes (FICA) for the first six months of such disability benefits.
If the salary continuation plan is unfunded, corporate payments made to the disabled employee are still tax-deductible (just as insurance premiums would have been). But an unfunded plan has the disadvantage of using company dollars instead of the insurer's money; also, when the disability strikes, there's no assurance that corporate income will be able to sustain the necessary payments.
The funded salary continuation agreement complements the disability buy-sell or BOE plan. Neither of these plans provide replacement of lost income to the disabled owner.
Finally, a formal sick pay plan can attract and help keep key employees. Key employees are difficult to find and often are just as difficult to retain in a company. Generally, this type of employee considers work-related benefits a vital part of the total compensation package. Employees who participate in a formal salary continuation plan have a tendency to stay with companies that provide a high degree of financial security.
