Presentation on theme: "Principal Life Insurance Company Disability Buy-Out Insurance"— Presentation transcript:
1 Principal Life Insurance Company Disability Buy-Out Insurance Presented By:NamePrincipal Life Title
2 This presentation is believed to provide accurate and authoritative information in regard to the subject matter covered. The accuracy of the content is not guaranteed, and it is provided with the understanding that Principal Life Insurance Company is not rendering legal, accounting, or tax advice. In specific cases, clients should consult their legal, accounting or tax advisors.
3 Have you planned for the future of your business? Have you taken the time to consider what would happen to your business if something happened to you? Making sure your business continues in your absence is an issue that is often postponed until it’s too late.Several disturbing questions surface when a business owner is unable to work due to an injury or sickness.Have you planned for the future of your business?
4 If You or One of Your Partners Became Disabled... Would you want to sell your share of the business?Would you want to buy out your partner?How would you determine the price?Where would the money come from?Will the money be there when it’s needed?Would you want to sell your share of the business?Would you want to buy out your partner?How would the price be determined?Where would the money come from?Is it guaranteed to be there when it’s needed?
5 What Are The Odds ...Do you know the chances of dying versus a disability?The likelihood of disability is, on the average, three times more likely than death before age 65.You protect you and your family in the event of a premature death -- shouldn’t you also protect your ability to work?Source: CSO, 1985 CIDB Table B9
6 Consider The Likelihood... No one likes to think of a disability striking them, but believing disabilities only happen “to the other guy” is a dangerous assumption. You might be surprised to know just how likely a disability is to occur.Take a look at this chart. Are you prepared to face the odds? Let’s find out. Assume you and your partner(s) are age 37...(Pick the age that seems most appropriate: 27, 37, 47, 57 and pick the number closest to the number of business owners there are: 2, 3 or 4 and look for the appropriate probability.)...The chance of one of the 3 (2, 3 or 4) of you becoming disabled is 34.5 percent. These aren’t good odds and they only get worse as you get older.Commissioner’s Individual Disability Table B - Equally Weighted 90 Day Elimination Period.
7 In the Event of a Disability,There Are Many Issues to be Resolved When you or one of your partners become disabled, there are many issues to resolve. For instance:Because the disabled owner is not contributing to the operation of the business, there is likely to be a drain on profits.Unless you’ve agreed before-hand, you and your partner may have different priorities for the business. Will you reinvest profits or distribute them?Are you prepared to let your spouse or another relative step in to the business if you become disabled? Or, if your partner is disabled, are you prepared to work with his or her spouse, relatives or an outsider?The disabled partner may:Become a drain on income while not contributing to the businessHave different priorities for the business income and profits and may not want to reinvest profitsDecide to let spouse or relative take over his/her role in the business
8 In the Event of a Disability, There Are Many Issues to be Resolved The healthy partner(s) may not be able to pay the disabled partner an income and still maintain the business. He or she may also not have the funds to buy out the disabled partner and be forced to go into business with someone they don’t know.The healthy partner:May not be able to pay the disabled partner an income and maintain the businessMay not have funds to buy the disabled partner outMay not want to share business decisions with the disabled partner’s family
9 A properly funded buy-sell agreement between owners will address the issues we just discussed. A properly funded buy-sell agreement between owners will address these issues.
10 Advantages of a Buy-Sell Agreement Assures active business owner can buy out the disabled owner at a predetermined price and pre-arranged time after disability strikesMaintains business continuity and credibility - which are concerns of customers, creditors and employeesThe active owner is ensured a smooth and complete transaction and can make decisions without the interference of the disabled owner’s family. He or she is able to keep control of the business and it also ensures that customers will continue to receive quality service, creditors will get paid, and employees stability.
11 Advantages to the Disabled Business Owner Creates an automatic market by guaranteeing a definite and fair price and a buyer for the business interestAssures that his/her financial future is no longer contingent upon the strength of the businessProvides money which may be needed to pay medical bills and living costsAvoids involving the disabled owner and his/her family in the management of the businessEnsures price - by establishing a funded plan each owner knows that whether they are the remaining owner or the disabled owner that their interests will be protected because a fair agreement has been established prior.
12 Advantages to the Active Business Owners Avoids negotiation of priceAssures complete and orderly transfer of ownershipRetains control of the businessCompetitors cannot purchase the disabled owner’s business interest in the firm and force out the active ownersThe active owner is ensured a smooth and complete transaction and can make decisions without the interference of the disabled owner’s family. He or she is able to keep control of the business and it also ensures that customers will continue to receive quality service, creditors will get paid, and employees stability.
13 Buy-Sell Considerations Date to Establish a PlanThe date the owner first becomes disabled; orThe trigger date of the buy-sell agreementMethod of paymentWhen is the first payment due?How should it be paid?Lump sum paymentMonthly installmentsCombination of bothDiscuss how you want the dollars paid.How will the buy-out be structured?
14 Buy-Sell Agreement Considerations Structure of the agreementCross-purchase agreementWorks best with two to three ownersInsurance company reimburses the non-disabled owner(s)Receive step up in basisEntity purchase agreementInsurance company reimburses the corporate entityBest to use with multiple ownersDiscuss how you want the dollars paid.How will the buy-out be structured?
15 The most practical solution is... A written agreement that specifies when and for how much the buy-out will take place, and...is funded with the right amount of Disability Buy-Out insurance.The most practical solution is to plan ahead by establishing a written agreement that specifies when and at what price the buy-out will take place, plus where the money will come from.
16 Why Disability Buy-Out Insurance? ObjectiveThe objective of Disability Buy-Out (DBO) insurance is to reimburse money paid for the purchase of a disabled owner’s interest in the business in the event of a long-term disabilityBenefitsBenefits are income tax-free - the disabled owner is taxed only on the gain from the sale of the business*Provides a funding solution for the business*Consult your tax advisor for details
17 How Does DBO Insurance Work The non-disabled owner(s) are reimbursed for buy-out expenses paid during the buy-sell processPremiums are non-deductible (IRC 265; Rev. Rul , C.B. 105)Benefits are received income tax-free (IRC 104(a)(3); Rev. Rul , C.B. 105)The disabled owner is taxed only on the gain from the sale of the business. The gain may be considered an installment sale if at least one payment is to be received after the close of the tax year in which the sale was made. Clients should contact their tax advisor for details.Several things to keep in mindTax issue.....premiums are tax deductible, and benefits are taxed as taxable income, however, you can still deduct the expenses that you incur on your schedule CKnow your client’s need for professional (i.e... lawyer, doctor, dentist engineer, etc.) or business overhead expense would be more appropriate. The difference between the two is that a professional overhead expense policy will usually allow the cost of a replacement to be included in the coverage.
18 Primary types of Buy-sell Agreements Funded with DBO Insurance There are two primary types of buy-sell agreements: cross purchase and entity purchase. Let’s look at how these arrangements work.Cross purchaseEntity purchase
19 Cross Purchase Agreement Each owner owns a policy on each of the other ownersAfter disability, the non-disabled owner(s) purchase the disabled owner’s share in accordance to the Buy-Sell Agreement and receives policy benefits (up to the maximum policy limit) as a reimbursementThe non-disabled owner(s) then own the business, and the disabled owner has been paid the price agreed uponEach owner owns a policy on the other. After disability the owner merely buys the other owner’s share.
20 How a Cross Purchase Agreement Works BusinessOwner ABusinessOwner BBuy-Sell AgreementPremiumPremiumPrincipalLifeThe buy sell agreement is between each owner. The premium going to Principal Life while the benefits go to the remaining owner to pay for the disabled owner’s portion of the business. These policies are done on a reimbursement basis. Only after an owner begins the buy-out process will they receive the funding.Policy andDisability Benefitson Owner BPolicy andDisability Benefitson Owner A
21 Advantages/Disadvantages of a Cross Purchase Agreement Policies are not available to business creditorsNon-disabled owners receive an increase in their basisDisadvantagesIf there are more than three owners, the number of policies needed may not be practicalIf the remaining owner sells the business there can be a tax advantage because of the increase in basis. This is the only possible tax advantage of cross purchase over entity purchase.However, a significant disadvantage is the number of policies that could be required under this plan. If there are more than 3 owners this is not a recommended method because of the number of policies that would be required.
22 Entity Purchase Agreement The business purchases and owns a disability buy-out policy on each ownerAfter disability, the business purchases the interest of the disabled owner in accordance to the buy-sell agreement and receives policy benefits (up to the maximum policy limit) as a reimbursementThe non-disabled owners then own the business, and the disabled owner has been paid the price agreed uponWith an entity purchase the buyout goes through the business entity. The remaining owner would then own the disabled partner’s portion, however, the basis points do not increase or decrease for either partner. The value transfers but the basis points basically “disappear” through the corporate entity.
23 How an Entity Purchase Agreement Works BusinessOwner ABusinessOwner BBuy-SellAgreementBuy-SellAgreementBusinessPolicy andDisability Benefitson Owners A and BPremiumIn this case the business owns the policy, the agreement is between the owners and the business and the $ is channeled through the business to the disabled owner.PrincipalLife
24 Advantages/Disadvantages of an Entity Purchase Agreement Only one policy per business owner is necessaryDisadvantagesPolicies are open to claims by creditorsThe buy-out will not increase the healthy owner’s basisAdvantagesNot as many policies needed, one per ownerDisadvantagesThis will not increase the owner’s basis and if the business is sold after the buy out the remaining owner would have to pay higher taxes.
25 Who needs DBO Insurance? Small to medium-sized businesses with less than 10 owners10% ownership to be consideredNeed to have a plan for successionOwners that depend on each other to keep the business running smoothlyProfessional Overhead expense is for the fee-for-service professional. In these cases the income of the business must solely depend upon the skills and experience of the professionalcheck into the employees can not generate revenue.
26 Common Methods to Calculate Business Value For Personal Service Businesses- 2 times income plus the profit of the businessFor General Businesses- Book value plus capitalization of excess earningsThese are the calculation methods that are most commonly used, however, if a client / CPA would like to use a different method most companies will at least take that into consideration.
27 Alternatives to not having DBO Insurance... Business cash flowSinking fund accumulationsLoans from financial institutionsDiscuss each one of the points and the pros or cons of each potential solution.
28 Act Now A disability can seriously impair the ability of a Close the client with this statement and ask for the appointment.A disability can seriously impair the ability of abusiness to function and can even threatenits existence.
29 Thank YouDisability insurance has certain limitations and exclusions. For costs and complete details of coverage, contact your Principal Life financial representative.Approval #