Disability Planning

There are plenty of good reasons to have individual disability insurance to replace your income should you become injured.  Disability coverage may be the least understood and most neglected area of business planning. Most people know that it’s important to prepare for a possible death, but rarely do they imagine that a partner or key employees will become disabled. Yet disability can be a lot more damaging to a business than death and is much more likely to happen.

Depending on when they were born, workers are about four times as likely to become disabled as they are to die before reaching normal retirement age, according to Social Security Administration

But if you own a business, it's not just about you. As a business owner, you’re probably the primary driving force of your business, as well as the bankroll. When you're planning for your business, one contingency you need to include is what would happen if you get sidelined. Here's the sobering statistic from the Council for Disability Awareness (CDA), an insurance industry group: One in four people entering the workforce will be disabled before retirement and can expect to be off the job for an average of 34.6 months. That's almost three years. It's not because they spend weekends racing motorcycles or commute long distances. Heart disease, back problems, cancer and other medical problems are more likely to cause disability than accidents.

Business owners have the option of establishing a wage continuation plan for themselves and their employees. These plans can help ensure that owners and employees can continue to be paid during a long-term disability. Consider the following advantages:

  • If structured properly, the payment of benefits to a disabled employee or owner may qualify as “necessary business expenses.” Under Section 162 of the Internal Revenue Code, these expenses may be tax deductible.
  • A wage continuation plan may promote loyalty among current employees, and attract and retain new employees.

Funding the Plan Once a commitment has been made to establish a wage continuation plan, potential funding options need to be considered, such as current revenue, retained earnings, or borrowing. On the other hand, disability income insurance can provide certain benefits, including the following:

  • Policies transfer the risk of salary continuation from the employer to the insurance company. So, a potentially open-ended expense is replaced with a leveraged, fixed business expense, such as the premiums.
  • When a qualified wage continuation plan is funded by a disability income insurance policy, the policy premium may be tax deductible as a business expense. To create a qualified wage continuation plan specific to the needs of a business, owners need to consult with their qualified legal advisor.

If a business pays the premiums for disability income insurance, the business may be able to deduct the premium payments as a regular business expense, provided such contributions are reasonable. Although the premiums are not considered taxable income to the employee, any disability income insurance proceeds received by the employee generally would be taxable income. Disability income benefits received from a policy during the first six months of a disability may be subject to Social Security tax (FICA) and Federal unemployment tax (FUTA).

However, if you are a sole proprietor, a partner in a partnership, or a more than 2% stockholder in a subchapter S corporation, you may not be able to deduct the cost of disability income insurance for yourself as a business expense, but you may be able to deduct the cost of such insurance coverage for your employees.

Customizing a Policy

Typically, disability income insurance can be tailored, often with riders, which may be available at an additional cost. Total cost for the policy is usually determined by the type and extent of coverage. For example, “own” occupation coverage (benefits paid for a disability that limits the ability to work in one’s chosen occupation) tends to be more expensive than “any” occupation coverage (benefits paid for a disability that limits ability to perform any gainful work).

The length of the elimination period (the waiting period before benefit payments begin) and the maximum benefit provided (stipulated by dollar amount, length of time, or a combination of both) are other significant variables in plan design and cost.

Another consideration in business disability planning is the completion of retirement funding for an owner who has sustained a disability. What happens when there are no contributions to an eligible retirement plan resulting from a disability? This problem may be addressed by purchasing a disability income insurance policy designed to help fund a shortfall in retirement planning.

Key person disability insurance and business overhead expense policies are two other important coverage options. Key person disability insurance provides a monthly benefit to the business based on the key employee’s pre-disability earned income. The benefit can then be used to provide revenue to hire and train a replacement or to strengthen the company’s cash flow. The second option, a business overhead expense policy, can help pay for overhead expenses should you become disabled under the terms of the policy. Therefore, if you are temporarily unable to generate revenue, the policy provides funds to reimburse specific business expenses, helping to keep the business operating without interruption.

Having a realistic understanding of the risks associated with sustaining a disability and the impact on your business and family, is the first step in looking for an appropriate policy to meet your needs. Be sure to consult with a qualified insurance professional about your unique situation.

You probably already have health insurance and life insurance for yourself and maybe for your employees, but you may be missing a crucial type of insurance: long-term disability insurance.

Long-term disability insurance, or LTDI, is designed to replace your income if you become disabled and can’t work. The insurance company pays you a benefit each month roughly equal to your income after taxes, which the carrier pays until the benefits period ends or you become well enough to work again.

Getting disability insurance as a small-business owner or independent contractor is slightly more complicated than getting it as an employee. However, it could be a lifeline while you’re recovering from an illness.

Consider several key steps as you comb through options with your broker.

When you have disability insurance, if you become so disabled that you can’t work, the insurance company will pay you benefits to help sustain you while you recover. These benefits replace between 60% and 80% of your income, or roughly your take-home pay.

When you purchase your LTDI policy, you agree to pay a monthly or annual premium to keep the policy in force. Your premiums are partly determined by the size of your benefits and the amount the benefits are supposed to last, which is called the benefits period. Under LTDI, benefits periods can last as little as five years or until you turn 67. (Short-term disability insurance, a related product usually only offered by employers as part of an employee benefits package, has a much shorter benefits period.)

Long-term disability is the best type of disability insurance for most people.

Let an experts help you find the perfect income protection policy.

1. Disability income for you and disability insurance for your business are two different issues. You need to provide coverage for both your family and your business.

For the home front: income coverage. Figure what you'll need to cover the mortgage, cable bill, car payments, tuition and food, among other expenses.

For the business: overhead coverage. Start with payroll, rent, utilities and any equipment or vehicle leases you carry. Employee benefits and advertising are two other costs.

How do you balance both? It's recommended that addressing your personal income needs should be first, then take on the business overhead coverage.

2. Shop professional and industry associations. Group rates are frequently cheaper than individual premiums. If you belong to a professional association, that's the first place to check for disability coverage rates. This is particularly important for stand-alone practices, which are likely to need a lower level of coverage (and have less financial muscle to dictate terms) than a larger business. The American Dental Association, for instance, sponsors disability income, overhead and business expense coverage for members at what potentially could be a discount.

3. Bundling gets you leverage. Another way to cut prices is to bring multiple needs to one carrier. You may get underwriters to come down on disability premiums if your company is large enough to add in group voluntary disability coverage for employees – or you can shop your personal disability coverage alongside your business overhead policy.

4. Read the fine print and consider adding riders to customize your coverage. Several key provisions will keep your family afloat and your business running. Each may end up adding to the amount you’ll need to budget for premiums, however, so investigate various options before you settle on a final policy.

“Own Occupation.” One key small-print factor is “own occupation” – a way of saying that you’ll receive full benefits as long as you aren’t working your original job. That’s an important consideration: If you are a construction contractor, you might work for a stretch as a draftsman, and you don't want to lose benefits because you did this.

Part time, full time. Use a magnifying glass on – and be sure you understand and can live with – wording in your policy that covers exactly how much you can collect in claims if you start back part time.

Replacements. Look over provisions for hiring a replacement to carry your burden and fulfill your duties on the job while you’re recuperating.

Cost increases. Inflation happens and will affect the value of your coverage. Check to see what your carrier does to adjust your coverage when costs climb.

5. Plan ahead. Start-ups – and their bosses – find it next to impossible to acquire disability or overhead coverage without a proven track record. If you’re planning to strike out on your own and your current employer offers disability income coverage, see whether you could retain the insurance after you leave and consider signing up before you hand in your resignation.

Establish an emergency fund: Overhead coverage policies typically set up a 30-day waiting period before paying claims. You may want to stash away a cushion to cover company outlays during that period.

6. Factor in your business structure. Disability can wreak havoc on different types of companies – sole proprietorships, partnerships or corporations – in a variety of ways. For an architecture firm where partners share clientele and costs, your time away will increase day-to-day pressures and fewer people will be billing to cover the partnership's monthly expenses. Then again, your engineering company might depend on two or three “brains” to solve some of the knottiest problems; losing you could affect its ability to provide services.

Structure disability overhead coverage to fill the gaps, depending on your company set-up. One option is to buy "key person” coverage that provides funding when a critical player is sidelined. This can work for a variety of business types.

If your business is a partnership, you and your partners should examine several other possibilities. One is disability buyout coverage, which can foot the cost of a disabled partner’s share if he or she will be out for so long that it makes sense to leave the business. Attorneys often recommend coupling buyout policies with a buy-sell agreement that spells out the terms – including the price paid for each partner’s share or the formula used to value chunks of the company.

The Bottom Line

Running a small business is taxing when you’re in the best of health. Considering how much your brainchild probably relies on you, it makes sense to protect it – and your family – from your inability to work when making insurance plans.