You’ve spent countless hours and probably a good bit of money building and growing your small business. What would happen if you or a key person in your business became disabled? How would that affect your business? It probably wouldn’t be a pretty situation.
As a business owner, you have inescapable responsibilities to your business and employees. Disability insurance protects businesses and their employees from the consequences of the disability of a key member of the company. While businesses of all sizes can use this protection, disability insurance is especially important to a small business owner, a professional with a small practice, and employees who rely heavily on these owners.
4 crucial disability policies
1. Business Overhead Expense insurance (aka BOE) – Pays the business expenses if the insured business owner or employee becomes disabled. It pays all expenses including payroll, except for the owner’s compensation, which is generally covered by a separate policy. The BOE policy has a short elimination period, often no more than a month, so that operating expenses can begin to be covered right away.
The benefit period should be long enough to cover the business for an extended disability and to determine if the owner will be able to return to the business, for example, in one to two years. Premiums are deductible, but benefits are taxable. As the benefits are used to pay operating costs, however, the addition to taxable income is offset by deductible expenses.
2. Disability Income insurance (aka DI) -The goal of individual disability insurance is to protect your ability to earn an income. Policies are usually long term contracts to age 65 or 67. Benefits are based on a percentage of income which varies based on occupation but not more than 60-80%. Rates are based on your specific occupation and job duties. Benefits are paid directly to you and are generally tax free (as long as premiums are paid by you and are not deducted).
3. Key Person disability insurance– The profitability of a company may suffer quite a bit if its best salesperson or executive is out of commission. These policies pay the company for the loss of a key person’s services during their period of disability. They are short term contracts usually only providing benefits for 6-24 months. They are designed to provide cash to the company until the key employee recovers or a capable replacement can be found. The only part that the employee has in this policy is that they’re the insured.
Benefits can be flexible and are not specifically based on the income of the key employee. They don’t make the premium payments or receive benefits if they become disabled, that’s the employer’s job. The employer’s premium payments are not tax-deductible, but the benefits are tax-free when received.
4. Buy-sell disability insurance– If an owner becomes disabled and can’t return to work after a certain time, it pays a lump-sum to the disabled partner in exchange for the sale of his or her interest in the business. It’s waiting period usually corresponds to the benefit period of their business overhead expense policy, which may be one to two years. After that amount of time, money to purchase the business is payable in a lump sum or in installments.
The Bottom Line
Running a small business is challenging, even when you’re healthy. Your business probably relies on you, so it makes sense to protect it and your family from your inability to work.