Business Disability Insurance

Business Need for Disability Insurance

Self-motivated individuals frequently play a crucial role in the success of a business. This is particularly true of small businesses in which one or two talented people possess highly specialized skills or knowledge that other employees do not have. If such a "key" person were to suffer a long-term disability, not only would the individual face substantial financial risk, but the very survival of the company could be in jeopardy.

Although sole-proprietorships and partnerships are generally the most vulnerable, corporations, particularly corporations built around one or two individuals, are also at significant risk. However the business is organized, when you consider the likelihood that you or one of your key employees may become disabled, there is a clear need to protect both your personal income and the financial well-being of the company.

Options to Consider

There is no single strategy or policy to protect your business from the risks posed by a key employee's disability. Like a puzzle, a number of pieces are needed to complete the picture:

  • Adequate cash reserves: Liquid funds can cover a short-term disability.
  • Key employee disability insurance: Pays income to a disabled key employee. If the employer pays any portion of the premium, then a proportionate amount of the benefit is taxable income to the employee. If the employer pays the entire premium, the entire benefit is taxable.
  • Business overhead expense insurance: This type of insurance covers normal operating expenses such as employee salaries, equipment leases, utilities, rent, advertising, maintenance, etc.
  • Qualified sick pay plan: The federal tax code prohibits a business owner from paying himself (or herself) a salary while disabled, and then deducting the payments as an allowable business expense. A formal, written qualified sick pay plan (also known as a salary continuation plan), established in advance, can provide for funding the disability benefits as well as maximizing the tax benefits.
  • Disability buy-out: In the event that you or another owner of the business suffers a permanent disability, disability insurance can be used to fund a buy-sell agreement.

Group Disability Insurance

As the name implies, a "group" disability insurance policy covers a number of people who are linked in some way, such as through an employer, a trade association, or a school. Benefits are paid to replace earnings lost due to accident or sickness. Premiums may be paid for by the individual, the organization, or both. Generally, the cost of group coverage is less expensive than the cost of individual coverage.

Factors to Consider

Group disability policies can vary widely. Factors to keep in mind include:

  • Benefit period: How long will benefits be paid?
  • Benefit level: How much (in dollar terms) will the benefit be? Disability income policies usually replace only a portion of an individual's income, typically 60%.
  • Risks covered: Does the policy cover both occupational (on-the job) and non­ occupational (off-the-job) injuries and illnesses, or just one of these?
  • Elimination period: How long do you have to wait before benefits begin?

Short-Term Disability (STD)

Group STD policies tend to have short elimination periods (1-14 days), typically cover non­ occupational illnesses and injuries, and generally pay benefits for six months to one year. Group STD policies are designed to cover temporary situations such as a broken ankle or a pregnancy.

Long -Term Disability (LTD)

There are times when an injury or illness will render an individual unable to perform the essential duties of his or her occupation for an extended period of time. Group LTD policies are designed to meet this type of need. Typically, group LTD covers both occupational and non-occupational illnesses and injuries (24-hour coverage), with longer elimination periods of six months or more. Since some injuries or illnesses are permanent, a group LTD policy may pay benefits for years.

Federal Income Tax Treatment of Disability Income Payments

For federal income tax purposes, if an individual pays for disability insurance with after-tax dollars, the benefits paid under a disability income policy are received free of federal income tax. If, however, the individual pays the premiums with pre-tax dollars, or if the premiums are paid for by someone else (an employer,for example), any benefits received are taxable income to the individual. State or local income tax treatment of disability income benefits can vary widely.

Seek Professional Guidance

In planning for a possible period of disability, the guidance of appropriate financial professionals is strongly recommended.