The reason, says the Melville, N.Y.-based fee-only planner, is that many partnership agreements cover what will happen in the event that one of the partners dies, but fail to address the possibility of one of the principals becoming disabled. Yet statistically, according to Frisch, people between the ages of 30 and 55 have a greater probability of becoming disabled than dying. And a disability that prevents someone from working puts heavy pressure on their spouse, partner or business to replace the lost income.
For this reason Frisch, whose client base includes numerous small business owners, emphasizes the importance of adequate long-term disability insurance. Policies, he notes, come in all shapes and sizes. Some high-end policies include inflation protection or other options to increase the amount of the benefit over time. Some policies only pay out until the beneficiary reaches age 65, while others continue to pay throughout the beneficiary’s lifetime. But the most important differentiator is how the policy defines ‘disability’ in the first place.
“Some policies cover against the inability to do ‘own occupation,’” he explains, where the covered individual doesn’t have to be totally disabled, just sufficiently disabled, or disabled in such a manner, that he or she is no longer able to continue working in their original profession. “Other policies require ‘total disability’—where the individual is unable to work in any capacity—before paying out.” So, he concludes, “how the policy defines disability is crucial.”
The other critical consideration, Frisch says, is how the policy is paid for. Long-term disability policies typically provide 60% of the disabled person’s salary, and many small businesses pay for the partners’ coverage, which is relatively inexpensive, and then write it off as a business expense.
While that amounts to a small benefit for the company, it comes at a huge disadvantage for the business owner, should he or she become disabled and dependent on the payout from the policy. That’s because, if the business pays for the policy, the beneficiary will end up having to pay tax on the benefit—which is already at only 60 percent of what he or she was previously earning.
Instead, Frisch is adamant that his clients pay the $2,000 to $3,000 annual premium themselves, so that the payout, should they need it, will not be subject to federal and state income taxes. “If the individual pays the premium out of pocket and becomes disabled,” he says, “they will never have to pay tax again.” And that, he notes, could amount to a 40% difference in the amount of income pocketed by the disabled person and their family.
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