A business disability buyout plan is designed primarily to buy out a disabled business owner or partner. The proceeds from the disability policy are issued to fund an agreement designed to provide the company owners with the financial resources needed to purchase a disabled owner’s or partner’s interest in the company or partnership at a mutually agreeable price.
A business disability buyout policy is specifically designed to fund a buy-sell agreement between the owners or between the owners and the company. According to experts, a disability buyout policy should be a critical part of any business continuation plan or business succession plan, especially since it helps to guarantee that the disabled business owner will get a fair market value for his or her interest in the business.
Aside from that, it guarantees that all business owners are protected from the issues and risks that a disability may impose on the company by allowing them to buy out the disabled owner’s interest at an agreed-upon price noted in the buy-sell agreement.
However, for a disability buy-out policy to be purchased, the business will first have to be well valued, and a buy-sell agreement put together and executed. Note that once a fair market value for the business has been determined, every party involved can then come together to agree on a sales price, and then a disability buy-out policy can be purchased on the life insurance of each business owner or partner.
In the event of a disability, note that there is a “waiting period” often referred to as the elimination period that will have to be met and verified before benefits can be paid. The elimination period, picked at the time of application, kicks on at the date of initial disability and can extend out 12, 18, or 24 months depending on the terms and conditions of the buy-sell agreement and the sustenance of the business.
And most often, the longer the elimination period, the lower the cost of the coverage will be. Once the elimination period is complete and every party is satisfied, benefits begin and there won’t be an additional need to ascertain continual disability.
Once a claim starts, the terms of the buy-sell agreement will be actualized and the policy will pay benefits according to the agreed terms. There are numerous benefit payment options such as a lump-sum payment or scheduled payments throughout two, three, or five years. A buy-out policy can also be tailor-designed to suit the specific needs of the company.
Potential Pros and Cons of a Business Disability Buyout Plan Policy
Before going on to design a business disability buyout plan policy, business owners must understand the potential pros and cons of disability buy-out insurance coverage so that they can get the best possible benefit.
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Truth be told, this agreement can be quite beneficial to both the business entity and the injured or ill person. For a business, this policy will help to protect the business against financial loss or even bankruptcy, and guarantee the continuity of operations and employment for those on staff.
Other owners or partners can also be assured control of their business decisions, with the freedom to replace the injured owner with a person of their choosing – and without any additional financial burden. Ideally, this agreement guarantees that owners will not be forced into business with any family members of the injured party.
The disability buyout plan policy also affords 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. In addition, 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).
One of the most notable disadvantages of this agreement is that it is not always tax-deductible, whether paid by the business or individuals. Depending on the type of entity, corporation, or partnership, the recipient of the benefits will be subject to capital gains taxes, gift taxes, or if the company receives the proceeds to disburse, be subject to the Alternative Minimum Tax.
Also note that individuals collecting disability insurance may find it challenging to find new insurance, especially since companies consider such person ineligible for various reasons including health conditions. In addition, if a person recovers from illness or injury, he or she will be left without a business, income, and livelihood.
Owing to that, it is imperative a disability buyout plan policy explicitly note 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.
Factors to Consider When Creating a Disability Buyout Plan Policy
If you are looking to design a disability buyout plan policy, here are the top factors to consider:
Your Type of Business Structure
Most often, a well-designed disability buyout plan uses life insurance as a funding vehicle to pay the deceased/disabled business owner’s family their own potion of the business interest. However, the number of owners in the policy will genuinely depend on the number of business owners or partners the business have and the type of business structure it has (S-Corp, C-Corp, LLC, Partnership, Sole-Proprietorship).
Always remember that choosing the wrong business structure can result in additional tax burdens, cause confusion, and has the probability to result in the liquidating of the business immediately whether you want to or not.
Buyout triggers are more or less the main events that trigger the agreement, and this will most often include retirement, death, divorce, disability, and failing to meet a contractual requirement, such as a capital contribution.
When designing your disability buyout policy, you must note the consequences of a triggering event, and that potential sellers are sure their shares will be bought and potential buyers are not forced to buy shares they cannot afford.
Value of Your Business
Just as it was noted above, for a disability buy-out policy to be purchased, the business will first have to be well valued. This value will have to be reviewed every 3-5 years to ensure every party involved gets the correct amount of interest in the business. In this ever-changing economy, it is very necessary to review this policy agreement now and then to regularly ensure that it aligns with the value the current value of the business.
Type of Agreement – Cross-Purchase vs. Entity Purchase
According to experts, there are two types of agreements in a disability buyout plan: Cross-Purchase and Entity Purchase. In a Cross-Purchase Agreement, each shareholder owns the life insurance of each shareholder, meanwhile, in an Entity Purchase Agreement, the life insurance funding vehicle is the property of the corporation.
Funding of Buy-Sell Agreements
Most times, businesses lack enough financial resources or cash reserves to buy out a shareholder’s spouse upon an unfortunate demise. However just as was noted above, a well-designed disability buyout plan uses life insurance as a funding vehicle to pay the deceased/disabled business owner’s family their potion of the business interest.
Purchasing life insurance can be a cheaper way to fund your business disability buyout plan. Knowing that the funds are available when unfortunate circumstances happen helps to reduce anxiety about a family’s livelihood and ensures the proper payout for a spouse.
Note that this is a legally binding agreement, agreed upon before anyone knows who will be the buyer and seller. It also stipulates the terms and conditions of the sale and subsequent purchase of the disabled party’s ownership of the business. Howbeit, do not forget that the disability policy will be of no benefit if it is allowed to lapse. Make sure that all required premiums are regularly paid.
You don’t want to leave yourself, your partners, and your families unprotected at a time when you are sick or injured. Also, remember to check up on the other funding components of your buy-sell agreement, and if the agreement is not adequately funded, push to have this done as soon as it is financially feasible for the company.