J—Disability Buy Out Insurance

Disability buy-out insurance is designed to provide funds for the purchase of a disabled owner’s interest in a corporation or partnership after an extended period of permanent and total disability. The benefits of such insurance include: (1) providing funds for the purchase, which funds are not tied to the continued success of the business; and (2) assuring that the disabled owner will no longer be a drain on business income and assets. In contrast, see the discussion of business overhead expense insurance.

A business is usually not eligible for coverage until it has been in existence for two years, although exceptions can be found (e.g., professional corporations). Maximum amounts of coverage typically range from $300,000 to $1,000,000, with specific amounts limited to a percentage of the owner’s interest (e.g., 80 percent of fair market value). As with disability income insurance, definitions of disability vary widely, from inability to engage in one’s “own occupation,” to inability to perform the duties of “any other occupation” for which one is reasonably suited. It is absolutely essential that the provisions of the purchase agreement be consistent with the definitions and terms of the disability buy-out policy.

Because a disabled individual’s chances of recovery are highest in the early months of his disability, the waiting period is extended and typically lasts from 12 months to three years. This attempts to avoid the forced sale of a business interest while the disabled owner might reasonably expect to return to work. Benefits are paid to the “loss payee,” who is that individual or business entity having the contractual obligation to purchase the disabled owner’s interest (i.e., entity purchase or cross purchase. Payment of proceeds can vary from lump sum to installment, with lump sum having the advantage of simplicity, but losing the tax advantage of spreading gain over a number of years.