Disability Buy Out

Many companies have life insurance on their partners, so in the unfortunate event of a partner’s death, shares can be bought out with the life insurance policy. But the most likely case is in fact a disability, so the partner may become – from the company’s point of view – “dead weight”.

Imagine if a partner has a heart attack: after 3 months he is back to work (no disability benefits were paid because of the 90 day waiting period or self insurance period), and his doctor has told him that he has to take it easy. So for this partner, only 10 – 20 hour work weeks are possible for the next several years.

Your best sales person is gone. But you can’t buy him out unless you have at least $500,000 cash. The critical illness policy could have taken care of that.

The Shareholders agreement should have a clear definition of disability. Example: mental and physical incapacity. The disability should be such that the shareholder or partner can not perform her duties within the business and a doctors certificate may be needed (example: “must be able to work at least 40 hours a week”). A time frame is also a wise idea – for example, how many days off work before the disability buy out starts (maybe after 6 months off).

Looking at a critical illness policy which will pay out a lump sum – tax-free – is probably the best way to consider this problem. A risibility policy, while good, will pay only 60% of the partner’s or shareholder’s income. This simply will not be enough to buy out the partner.

How to pay for these policies. An employer might also purchase critical illness policies on the lives of a group of employees. Each insured employee would be beneficiary of the policy on his or her life. The premiums should be deductible to the employer. However, a good case exists for this arrangement to be considered a “group sickness or accident insurance plan”, in which case no taxable benefit would be incurred by the employees for premiums paid by the employer. Plus, the employee would not be taxed on any benefits received.

The above is for illustration only; please contact me to review your situation.

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