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The Need for Disability Planning

Most insurance professionals don’t discuss disability insurance with their clients, and most clients grossly underestimate the need for it. However, we’re entering a period when the need for disability planning will convince savvy business owners to explore their options.

Around half of home foreclosures are due to disability. A 35-year-old, white-collar male who suffers a disability lasting 90 days or longer will be out of work for an average of six years (compared to slightly less than four years in the 1970’s and 80’s). The likelihood of suffering such a disability for a male between 35 and 65 is 27% and for a female it is 34%. A fatal misconception is that disabilities, if they occur, will be short term events. Among people over 35 who are disabled for 90 days, more than half will still be disabled after five years.

Business owners should establish a salary continuance plan in writing before a disability occurs. The document also known as a Qualified Sick-Pay Plan (QSPP) is a written plan in which an employer makes provisions to continue paying employees who become disabled and unable to work. It’s not always insured, but it usually makes economic sense to use insurance as a funding vehicle.

Consider the case of Chism Ice Cream Company: E.W. Chism was the founder and president of Chism Ice Cream and was seriously disabled in 1952. His company continued to pay his salary and deducted it as a legitimate business expense. The IRS disagreed, denied the deductions, and subsequently won and ruled that no sick pay plan had ever been in place. The company was forced to pay back taxes, penalties and interest. Any salary paid outside of a written plan may be treated as corporate dividends and become non-deductible to the company.

A QSPP is the business’s plan if someone becomes too sick or hurt to work. Within the planning process the business owner can determine: 1) who’s covered under the plan (within general discrimination rules, the employer can select, by class, the covered group under the plan), 2) how long the employee needs to be disabled before the disability benefits are payable, 3) the benefit schedule (flat dollar amount, The Need for Disability Planning By Pat Hubbard, CFP ®, CLU, ChFC ● Insurance Agent percentage of salary, etc.), and 4) how long benefits are payable. Detailing these items enables you to develop a plan that fits your unique needs.

Once you develop a QSPP, the next decision to be made is whether or not to fund. Upon completion, the plan is automatically considered “funded” by the employer, whether or not funding actually exists. If the plan is uninsured, the entire responsibility of funding falls on the business. The disability of a covered employee places the unfunded plan in jeopardy because of FASB 112, a Statement of the Financial Accounting Standard Board that requires employers who provide self-funded benefits, to recognize and account for them.

An uninsured disability benefit becomes a current liability and an expense equal to the present value of future benefits. This liability must be accounted for on the company’s financial statement, and insurance satisfies the financial reserve requirements of FASB 112. Typically, the cost to insure is 1.5-2% of payroll and deductible as a normal business expense.

Salary continuation plannings enables business owners to use well established IRS rules and regulations to their advantage. A plan enables employers to provide meaningful benefits within a budget, while meeting the needs of employees when they’re disabled.

Pat Hubbard, CFP®, CLU, ChFC is the owner and president of The Hubbard Planning Group, Inc in Jacksonville. He can be reached at 904-399-8883 or phubbard@hubbardplanning.com.