buy-sell disability insurance

Do you offer Buy-Sell Disability Insurance to your business owner customers? If you don’t, you could be leaving a significant amount of revenue on the table – not to mention opportunities to serve your customers better.

The Market for Business Succession Planning

According to the Brookings Institute, 11% of American businesses are partnerships. That means that about 3.58 million of the 32.5 million U.S. businesses are owned by two (or just a few) partners.

These partners may have a buy-sell agreement that stipulates how much their family would receive as their share of the business in the event of their death. The agreement may also cover the buyout terms in the event of early retirement. Buy-sell agreements include funding provisions, such as a life insurance policy, to pay for a buyout.

But many buy-sell agreements do not address the prospect of an owner becoming disabled. This is in spite of the fact that insurance industry statistics consistently reflect that the odds of sustaining a long-term, disabling illness or injury before age 65 are much greater than the chance of dying prematurely.

Buy-sell agreements are usually part of an overall business succession plan. A business succession plan provides the transfer of ownership and management of a business in the event of an owner’s disability, retirement, or death. A well-constructed business succession plan does the following:

  • Ensures continuation of the company, avoiding a business interruption or forced sale
  • Ensures that remaining partners have the funds needed to buy the missing owner’s interest in the business
  • Ensures line up of a potential buyer ahead of time
  • Provides the missing owner’s family with funds they may need

The business succession plan can set a price for each owner’s business interest and ensure that enough money is available to cover the missing owner’s interest in the company to transfer ownership to the remaining owners.

Why Buy-Sell Disability Insurance Is Important

Buy/sell agreements address the events of retirement and death. However, many (if not most) overlook the topic of what the partners should do if one of them becomes too hurt or sick to function as an active working partner.

With so many small business owners serving as essential employees in their businesses, imagine a scenario in which one business partner suffers a disabling accident or illness:

  • How long can the company carry on without needing to replace that person’s contributions to daily operations?
  • Does the business have the financial wherewithal to replace the disabled owner with an employee?
  • What about the awkwardness of remaining partner(s) suddenly carrying the entire burden of running the business independently?

Buy-Sell Disability Insurance provides the funds needed to buy a partner’s interest in the business if they become disabled while minimizing associated tax liability. The coverage provides the remaining partners the money required to replace the partner who cannot return. This allows the business to continue operating without putting the company at risk of financial catastrophe.

Some Buy-Sell Disability Insurance plans pay only in the event of total and permanent disability. Others provide cash benefits once a disability has lasted for at least a year.

Disability buy-out insurance is a superior business strategy compared to other choices such as taking from future earnings, exhausting savings, or taking out small business loans. Such a policy should be part of any business succession plan or continuation plan. In addition to protecting the business financially, it ensures that the disabled owner will receive a fair payout for their share of the company’s value.

Having this arrangement in place can also save the personal relationship between the owners/partners by not subjecting either side to more than their share of the burden.

How Buy-Sell Disability Insurance Works

After an elimination period of 12 months, Buy-Sell Disability Insurance benefits are paid out either as a lump sum or annually for years.

Buy-sell disability policies are designed to fund the buy-sell agreement in place, so they typically mirror the buy-sell agreement developed by the partnerships. These agreements can take a few different forms.

  • Cross purchase agreements state that when one partner needs to sell their stake in the business due to disability, the other partner or partners will buy the stake of the disabled partner.
  • Entity purchase agreements state that the company will buy the disabled owner’s share.
  • Wait and see agreements give the partners flexibility to determine whether a cross purchase agreement or entity purchase agreement makes more sense when the need arises. This can make sense because the buy-sell agreement might not be invoked for years or even decades, and a lot can change during that time.

Learn more about how buy-sell disability insurance works.

Learn about the different types of buy-sell agreements.

Benefits for the Active Owners/Partners

An unexpected illness or injury can be very disruptive to business operations. Without an agreement already in place, the active owners and partners may face a great degree of uncertainty. A buy-sell agreement with buy-sell insurance funding can create a clear path ahead. The active partners receive the following benefits:

  • Acquire the business interest of the disabled owner at a fair price
  • Maintain ownership and control
  • Receive tax-free benefits
  • Smooth transition of ownership
  • Relinquish the decision of when a third party meets the definition of total disability

Benefits for the Disabled Business Owner

The disabled partner may be worried about their own finances as well as the fate of the company they’ve worked hard to help build. A buy-sell agreement funded by insurance can soothe these concerns. The disabled partner receives the following benefits:

  • Receives the proceeds for their business interest
  • Can worry less about future business value fluctuations
  • Taxed only on the gain from the sale of the business (usually at more attractive capital gains rates)

Tax Implications of Buy-Sell Disability Coverage

Buy-Sell coverage is considered personal insurance. Thus buy-sell disability insurance premiums are not tax-deductible, but any benefits paid out are tax-free.

The disabled owner will generally recognize a capital gain on the difference between their basis in the business and the price the other partners paid to buy that interest.

Capture Your Share of the Business

Although many business owners include life insurance policies in their succession and buy-out plans, a surprising number overlook disability policies. This creates a tremendous opportunity for agents, especially those of you who work with numerous small business owners.

When working with a small business owned by more than one person, offer a Buy-Sell Disability Insurance policy for the company and an individual disability insurance policy for each owner.

In addition, consider offering business owners a business overhead expense (BOE) policy. This policy pays for certain overhead costs if an insured business owner is disabled, including rent, utilities, payroll, employee benefits, equipment leases, advertising, etc.

It’s important to understand that a buy-sell agreement is an opportunity to get small business owner clients engaged in exit planning. You may or may not be an expert in buy-sell agreements. Either way, you can still provide your clients with substantial value by having a conversation with them. Talk about different scenarios and consequences so they can make adequate plans before such plans are needed.

Although many consider Buy-Sell Disability Insurance coverage too expensive, it is remarkably affordable given the multiple advantages and security. Premiums are certain, anticipated, and predictable. Buy-sell disability insurance removes the buyout financing burden from the individual owners to the insurance carrier.

The Social Security Administration estimates that about one-fourth of all Americans who are now 20 years old will become disabled before reaching retirement age. According to actuarial tables, in a business with three partners at an average age of 37, there is a 78% chance that at least one partner will become disabled before retiring. Now consider premium costs for a Buy-Sell Disability Insurance policy.

For a premium of about $500 per month, a three-partner CPA firm with average partner age of 35 years and a current business valuation of $1.5 million could buy a disability buy-out insurance policy covering all three partners if one should become disabled through injury or illness. Underwritten by a major carrier, the policy would include guaranteed premiums until retirement age and a premium waiver to keep premium payments up to date in the event of disability.

Explain to your business clientele the importance of addressing potential disability in their succession plans. Ask to see their business succession plans and buy/sell agreements.

The same principles that make it a wise move to have a life insurance policy fund a buy-sell agreement on death apply to the use of Buy-Sell Disability Insurance to support a buy-sell agreement upon permanent or long-term disability. Even if the business has plenty of capital, insurance may still be the best way to fund the buy-sell agreement.

Are you ready to start protecting your clients with buy-sell disability insurance? Download the Buy-Sell Agreements Guide & Client Handout.


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