Disability Buy-Out Insurance
Prudent business owners know the importance of thorough business planning and the impact that the death or disability of a principal owner could have on the future operations of any company. Disability buy-out or disability buy-sell insurance is the best way to protect the business in the event that an owner becomes permanently disabled.
- What is Disability Buy-Out Insurance?
- How does disability buy-out insurance work?
- Why buy disability buy-out insurance?
- Important considerations of disability buy-sell planning
- Taxation of disability buy-sell plans
What is Disability Buy-Out Insurance?
Disability buy-out insurance is designed to provide the funds needed to purchase a disabled owner or partner’s interest in the business if they become disabled. Disability buy-out insurance should be made part of any business continuation plan or business succession plan as it will assure that the disabled business owner receives a fair market value for his or her interest in the business. At the same time, it will protect all business owners from the threat that a disability may impose on the company by allowing them to buy-out the disabled owner’s interest at an agreed upon price set forth in a buy-sell agreement
Why buy disability buy-out insurance?
The statistical probability of an individual disability is greater at any age than the likelihood of death in that same year. The disability of an owner who is active in the day to day operations of the business can present huge financial problems. To understand more about the potential threat a disability may be to your organization, ask yourself the following questions:
| 1. | What impact would the disability of a partner who is a key contributor have on the company’s income? |
| 2. | Where will the money come from to pay an income to the disabled owner? |
| 3. | Does the business have adequate funds to buy out the disabled partner’s share? |
| 4. | Will the firm have to borrow money to buy out the disabled partner? |
Important considerations of disability buy-sell planning
| 1. | What defines a disability from the business’ perspective? This must be established in the buy-sell agreement prior to executing a disability buy-out policy. |
| 2. | How long does a partner have to be disabled before the buy-out is executed and the disabled partner’s interest is sold to the remaining partners? As mentioned above, the elimination period is generally set for 12 to 24 months depending on the terms of the agreement. |
| 3. | What are the terms of the buy-out? Will benefits be paid in one lump-sum or over time? |
| 4. | What if the disabled individual recovers after the buy-out is triggered and the disability policy ceases to pay benefits? |
Taxation of Disability Buy-Sell Plans
The premium payments for disability buy-sell policies are not tax deductible. Therefore, the benefits received are income tax free. Depending on the type of entity, corporation or partnership, the recipient of the benefits may be subject to capital gains taxes, gift taxes or if the company receives the proceeds to disburse, be subject to the Alternative Minimum Tax.*
For additional information on business planning see:
- What is Business Continuation Planning?
- What is a Buy-Sell Agreement?
- Determining the Value of a Business
* Neither MEG Financial nor any of its
licensed agents are providing specific tax advice. All tax
related questions
should be directed to your company’s CPA or tax advisor.
