What Happens When A Business Partner Becomes Disabled
Introduction
If your firm has multiple partners/owners, there should be a written Partnership Agreement. If there is not a current Partnership Agreement, that details not only what will happen at the death or disability of an owner, but also how the owner's share of the company will be calculated, one should be drawn up immediately. If your firm does not have partners but there are key people in the firm, there are ways to protect the firm from their death or disability. Please contact us for further details on Key Person Insurance.
Many firms have purchased life insurance on the partners/owners to assist the firm in buying out a deceased owner's share. As important, but often neglected, firms need to make arrangements to buy a partner out should they become disabled for an extended period of time.
If a partner became disabled and was unable to continue working, there are some very important questions that need answering. Would the other partners buy out the disabled partner's interest? What price would they be interested in paying? And, would the disabled partner accept that price? How long can the business afford to operate without the disabled partner? How long can the business continue paying the disabled partner's salary and percentage of profits?
A Disability Buy-Out Insurance policy will fund a written Partnership Agreement to provide the company with the money needed to purchase a disabled partner's interest at a mutually agreeable price - and at the exact time that it's needed.
Designing a Policy There are three basic decisions to make when buying a Disability Buy Out Policy.
Total Benefit: This number would be based on the market value of the firm and the percentage ownership of each partner. Some firms choose to insure the total market value of the firm. Other firms choose to insure an amount less than the firm's full market value. In either case, each partner's ownership percentage dictates the amount of coverage needed for that partner.
Elimination Period: This is the length of time from when the partner becomes disabled until the policy will pay a benefit - in effect, it's the policy's deductible. Most policies have an option of a 12, 18, or 24 month Elimination Period that you choose when you buy the policy. A Partnership Agreement addressing Disability must be in place in order to purchase this insurance. The Partnership Agreement will dictate the length of a disability before a partner is bought out. Most firms go with 18 months. The idea is to provide enough time to be sure the disabled partner will not be able to return to the business - but not so much time that the business is crippled in the interim.
Pay Out Period: When you purchase the policy, you need to decide how the payment at disability will be structured. Again, the Partnership Agreement will assist you in making this decision. Options will be either Lump Sum Pay Out at the end of the Elimination Period or Installments over a period of time up to five years. The longer the pay out, the less expensive the policy is.
Reasons to Consider this Coverage A disabled partner generally represents a dual liability to the company. First, the company must usually continue the disabled person's income during the disability period. Second, the remaining partner must take up the slack caused by the absence of the disabled person and/or hire a temporary replacement. By purchasing the policy before the disability strikes, the business can provide a mutually agreeable solution to a very difficult situation.
The advantages to a disabled partner include:
assures a definite price and buyer under mutually agreeable conditions
no need to worry about the ability of the business to meet the buy-out commitment avoids costly and time-consuming litigation trying to reach a fair price
family members can direct their attention to assisting the disabled person instead of worrying about protecting their share of the business
The advantages to the active business partner include:
assures they can buy-out the disabled partner's share at a price and a time agreed to by everyone concerned, at minimal cost to the business (the cost of the insurance vs. the cost of the buyout)
active partners remain in control of the business
creditors, clients, and employees are assured of business continuity
assures the disabled partner will not sell their interest to an outsider because of cash needs
The insurance premiums are not tax-deductible and any benefits paid to the company are free of income taxes. Funds paid to the disabled partner are taxed as a capital transaction, as the firm is buying their share out.
Any agreements and insurance policies within a business must be integrated with the overall plan and objectives of the business. Careful consideration must be given to the selection of the plan which is right for the business and to the method of funding the plan.
We Can Help This material contains only general descriptions. For information about specific insurance needs or situations, consult Brian P Boak, CLU, LUTCF at 201-837-1100 or Brian.Boak@
