Major illness or injury is simply a fact of life for many Americans; the Social Security Administration estimates one in four 20-year-olds will become disabled before the age of 67. For many business owners, disability buy-out coverage, a valuable type of business insurance, provides the money needed to purchase a disabled owner or partner’s financial interest in a company, may be a prudent financial decision — both for the disabled individual and the business interests of the company as a whole.
How Disability Buy-Out Insurance Works
Disability insurance provides peace of mind for an individual who has been severely injured or has a long-term illness, as it replaces lost wages for the injured or ill party. At the same time, the company is afforded the ability to pay the individual through a buy-sell agreement, which provides the money needed for a business to buy out the affected person’s share (at an agreed upon price). This is a legally binding agreement, settled upon before anyone knows who will be the buyer and seller, that sets forth the terms and conditions of the sale and subsequent purchase of the disabled party’s ownership in the enterprise.
There are a few ways money agreed upon in the buy-sell agreement might be paid out to the disabled individual: lump sum payouts, monthly disbursements, or a combination of both. A typical policy will be issued to an adult under 60 years of age, with a minimum payout of five thousand dollars and a maximum of two million dollars. If an additional sum of money is needed, the business can go through a provider that offers additional coverage. While a lump sum will pay out the full, agreed upon amount, monthly payments can be paid in installments over a time period varying from 12 to 120 months. A combination policy may involve an initial sum of money that will be paid out, with the remainder to be disbursed incrementally.
The buy-sell agreement can be an entity purchase plan, in which the business purchases the disabled owner or partner’s stake in the company. In this scenario, the company pays premiums for the policy and is its beneficiary. Another option is known as a crisscross agreement, meaning co-owners of the business (as individuals) purchase the disabled party’s interest; therefore, each individual pays premiums and receives benefits from the disability policy covering the affected party. A third option is a trusted cross-purpose agreement between a third-party trustee and the business’ partners or stockholders.
After an illness or injury occurs, there is a specified waiting period, also known as an elimination period, before benefits are paid. This period of time can be as long as a year or two.
The agreement can be advantageous for both the business entity and the injured or ill person.
For a business, disability buy-out insurance may guard against financial loss or even bankruptcy, ensuring the continuity of operations and employment for those on staff. Owners also can be assured control of their business decisions, with the freedom to replace the injured owner with a person of their own choosing – and without any additional financial burden. Moreover, this agreement ensures owners will not be forced into business with any family members of the injured party.
Meanwhile, the affected individual is afforded peace of mind about his financial needs. Since the agreement has stipulated a set price for this purchase, agreed upon by all parties, the disabled owner or partner can feel confident he/she will receive a fair market price for his share in the enterprise.
One potential drawback is that this coverage is not always tax-deductible, whether paid by the business or individuals. Similarly, payments disbursed through the buy-out agreement are not always tax-deductible, as they are considered a capital transaction.
An individual collecting disability insurance may have a tough time getting new insurance, as companies may deem that person ineligible for various reasons including health conditions.
If a person recovers from illness or injury, he will be left without a business and a livelihood. Therefore, a policy should specify whether the individual can buy back shares in the company while the payout period is still ongoing, and if so, how ownership will be transferred back. Shorter payout periods may increase the likelihood the individual will have sold all interest in the business before he has recovered.
Contact BBG For More on Business Insurance Coverage!
To learn more detailed information about disability buy-out insurance policies and if one is appropriate for your business, contact The Business Benefits Group’s Business Insurance consultants by sending us a message online or by calling us today. We can help you identify potential problems your company may face and devise a coverage strategy which will effectively mitigate these risks.