Many business owners have life insurance to help protect the financial well-being of their families in the event of their death. They also have property and casualty insurance to help cover the value of their personal belongings in the event of damage, fire, or theft. However, many business owners may overlook one of their most valuable assets, which is their ability to earn an income.
Despite the risk involved of sustaining a disability, many business owners lack disability insurance, making them vulnerable to financial challenges. For instance, how would you pay for housing, insurance, food, transportation, and clothing if you should sustain a disability that prevents you from working for a period of time? Would your business be able to continue generating income? Would you have enough savings to support yourself and your family during an extended disability or fund disability benefits for an employee?
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.