As a young, single woman in the insurance business, my natural market is with young, single professionals. Therefore, disability income insurance products are among my best friends in the business because the policies are age appropriate to my primary demographic market.
Yet when I look at other disability insurance professionals, I cant help but wonder if some are missing opportunities hidden in the DI business and even the employee benefits business. Often, when working with a new individual or group client, I find a gap in coverage that reveals such an opportunity. One example is in the area of salary continuation plans (SCPs).
Group long-term disability replaces income of an employee if disabled for typically longer than 90 or 180 days. This benefit can provide 60% of an employees gross salary. However, the Internal Revenue Service can consider this money taxable as ordinary income and the employee may actually get closer to 40% of income after taxes.
Group long-term disability plans frequently discriminate against highly compensated employees. Most group contracts provide coverage to a monthly maximum. In our office, that can range anywhere from $6,000-$7,000 of pretax monthly benefit, to $10,000 if the carrier is impressed by the companys demographics.
Lets suppose a contract guarantees coverage to a maximum monthly benefit of $10,000 for 1 year, making the maximum benefit $120,000 annually (60% of a $200,000 salary). Many workers could live with this amount on a pretax basis every year, but for those accustomed to a $200,000 annual salary, the $120,000 benefit may not seem enough. Say the CEO of start-up XYZ earns $250,000 annually, has 40 employees and pays private school tuitions for her 3 children. After taxes, that $120,000 probably will not cover her mortgage and the private school tuition of the 3 kids, let alone everyday expenses. It is in this type of situation that a SCP using DI can really helpand it can boost the value of the advisor in the process.
How It Works. Here is the typical process for establishing a SCP. Once the plan is adopted, the employer purchases individual DI insurance policies for key employees. The premiums are deductible business expenses (IRC Sec. 162), and the key employees income is protected to 75%. In the end, key employees receive income replacement should they become disabled while the cash flow of the employer remains protected.
Under a traditional SCP, the additional income provided by the SCP is still taxable to the employee. Benefits received by a disabled employee under a formal plan will be taxable as income (IRC Sec. 61). In some instances, a tax credit may be available (IRC Sec. 22).
To avoid this, the employer has the option of establishing a “bonus up” arrangement for its SCP that would allow key employees to receive benefits tax-free. To do this, the employer “bonuses up” the employees W-2 income in the amount of the premium, so not only does the employer receive tax benefits by offering the plan, but the employee is now covered and will receive a tax-free benefit. (Note: The employer pays the premiums with the bonus-up option, so it does make the program more costly.)
As a word of caution, there are 2 special rules with regards to this “bonus up” arrangement.
First, there is a 3-year look back rule. If the individual LTD policy has been employer-paid for 1 or more years, and then the employer implements a bonus-up arrangement, the tax rules say the taxation of the benefits under the policy will be looked at based on the 3 years of premium payments prior to the claim. So, it is a pro rata formula: If in the last 3 years there were 2 years of employer-paid premium, and only 1 year of the bonus-up arrangements through additional bonus payments, only one-third of the benefit will be tax-free.
Second, the bonus-up has to be a regular and ordinary practice of the employer. It only can be done for a class of individuals. Example: A class could be defined as director-level and up or vice president level and up, depending upon company structure. A bonus-up arrangement cannot be done for just a few individuals who are not members of a class as defined in the arrangement. Also, a bonus-up cannot be done retroactively without making it appear to be a questionable arrangement implemented just to benefit a few people who expect to go on disability claim.
Implementation. Establishing a plan is easy, and can be completed in 3 steps. First, establish a corporate resolution adopting the SCP; without this, the employer cannot deduct the premiums pretax. Second, draft and distribute a letter announcing plan benefits to key employees. Finally, the employer purchases individual DI policies on the key employees. (An insured plan is exempt from ERISA filing requirements if there are less than 100 covered key employees.)
The box on this page shows the multiple advantages that SPCs offer to employer, employee and advisor. This makes a strong case for including SPC in the practice.
is a Bethesda, Md., licensed agent of MONY Life Insurance Company and a registered representative of MONY Securities Corporation, member NASD, SIPC. Both firms are subsidiaries of AXA Financial, Inc. Her e-mail address is firstname.lastname@example.org.
Reproduced from National Underwriter Edition, March 4, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.