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Principal Life Insurance CompanyDisability Buy-Out Insurance
Presented By:Name Principal Life Title
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.
Have you planned for the future of your business?
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 the price be determined?
• Where would the money come from?
• Is it guaranteed to be there when it’s needed?
What Are The Odds ...
0
5
10
15
20
25
27 32 37 42 47 52 57Current Age
Oc
cu
rre
nc
e p
er
Th
ou
sa
nd
Death Disability
Source: 1980 CSO, 1985 CIDB Table B
Consider The Likelihood...
Chances of a Disability Lasting 12 Monthsor Longer (before age 65)
Age 2 Owners 3 Owners 4 Owners27 26.3% 36.7% 45.7%37 24.5% 34.5% 43.1%47 20.7% 29.4% 37.1%57 12.1% 17.6% 22.8%
Commissioner’s Individual Disability Table B - Equally Weighted 90 Day Elimination Period.
In the Event of a Disability,There Are Many Issues to be Resolved
The disabled partner may:
• Become a drain on income while not contributing to the business
• Have different priorities for the business income and profits and may not want to reinvest profits
• Decide to let spouse or relative take over his/her role in the business
In the Event of a Disability, There Are Many Issues to be Resolved
The healthy partner:
• May not be able to pay the disabled partner an income and maintain the business
• May not have funds to buy the disabled partner out
• May not want to share business decisions with the disabled partner’s family
A properly funded buy-sell agreement between
owners will address these issues.
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 strikes
• Maintains business continuity and credibility - which are
concerns of customers, creditors and employees
Advantages to the Disabled Business Owner
• Creates an automatic market by guaranteeing a definite and fair price and a buyer for the business interest
• Assures that his/her financial future is no longer contingent upon the strength of the business
• Provides money which may be needed to pay medical bills and living costs
• Avoids involving the disabled owner and his/her family
in the management of the business
Advantages to the Active Business Owners
• Avoids negotiation of price
• Assures complete and orderly transfer of ownership
• Retains control of the business
• Competitors cannot purchase the disabled owner’s
business interest in the firm and force out the active
owners
Buy-Sell Considerations
• Date to Establish a Plan• The date the owner first becomes disabled; or• The trigger date of the buy-sell agreement
• Method of payment
• When is the first payment due?
• How should it be paid? • Lump sum payment
• Monthly installments
• Combination of both
Buy-Sell Agreement Considerations
• Structure of the agreement• Cross-purchase agreement
• Works best with two to three owners
• Insurance company reimburses the non-disabled owner(s)
• Receive step up in basis
• Entity purchase agreement• Insurance company reimburses the corporate entity
• Best to use with multiple owners
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.
Why Disability Buy-Out Insurance?
• Objective• The 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 disability
• Benefits• Benefits 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
How Does DBO Insurance Work• The non-disabled owner(s) are reimbursed for buy-out
expenses paid during the buy-sell process
• Premiums are non-deductible (IRC 265; Rev. Rul. 66-262, 1966-2 C.B. 105)
• Benefits are received income tax-free (IRC 104(a)(3); Rev. Rul. 66-262, 1966-2 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.
Primary types of Buy-sell Agreements Funded with DBO Insurance
• Cross purchase • Entity purchase
Cross Purchase Agreement
• Each owner owns a policy on each of the other owners
• After 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
reimbursement
• The non-disabled owner(s) then own the business, and the
disabled owner has been paid the price agreed upon
How a Cross Purchase Agreement Works
Premium
BusinessOwner A
BusinessOwner B
Buy-Sell Agreement
PrincipalLife
Premium
Policy andDisability Benefits
on Owner B
Policy andDisability Benefits
on Owner A
Advantages/Disadvantages of a Cross Purchase Agreement
Advantages
• Policies are not available to business creditors
• Non-disabled owners receive an increase in their basis
Disadvantages
• If there are more than three owners, the number of policies needed may not be practical
Entity Purchase Agreement
• The business purchases and owns a disability buy-out policy on each owner
• After 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 reimbursement
• The non-disabled owners then own the business, and the disabled owner has been paid the price agreed upon
How an Entity Purchase Agreement Works
BusinessOwner A
BusinessOwner B
Business
PrincipalLife
Premium Policy andDisability Benefits
on Owners A and B
Buy-SellAgreement
Buy-SellAgreement
Advantages/Disadvantages of an Entity Purchase Agreement
Advantages
• Only one policy per business owner is necessary
Disadvantages
• Policies are open to claims by creditors
• The buy-out will not increase the healthy owner’s basis
Who needs DBO Insurance?
• Small to medium-sized businesses with less than 10 owners
• 10% ownership to be considered
• Need to have a plan for succession
• Owners that depend on each other to keep the business running smoothly
Common Methods to Calculate Business Value
• For Personal Service Businesses
- 2 times income plus the profit of the business
• For General Businesses
- Book value plus capitalization of excess earnings
Alternatives to not having DBO Insurance...
• Business cash flow
• Sinking fund accumulations
• Loans from financial institutions
Act Now
A disability can seriously impair the ability of a
business to function and can even threaten
its existence.
Thank You
Disability insurance has certain limitations and exclusions. For costs and complete details of coverage, contact your
Principal Life financial representative.
Approval #641292005
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