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 ...

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20

25

27 32 37 42 47 52 57Current Age

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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