Individual Disability Income Insurance
One of the most overlooked components of a sound insurance program is disability income insurance coverage. Many people give little thought to how they would handle financial responsibilities, such as mortgage payments, car payments, college tuition, grocery bills, and utility expenses, if their income suddenly ceased for a period of 90 days or more. If you are a small business owner, it is no different. If a disability were to occur, not only would your income stop, but your business could also potentially come to a halt. Therefore, you should take steps to prepare yourself and your family for unforeseen events that could cause financial difficulties.
What about Social Security or “Group” Coverage?
Social Security will most likely not replace your lost wages in case of a serious illness or accident. You must be severely disabled to qualify for Social Security disability benefits, and even then, you will have to wait at least six months for payments to begin.
If you have a group disability policy for your business, it is possible that such coverage may only be short term (less than six months) in nature. What would happen if you were disabled permanently or for an extended period of time? Because a sudden cessation of income could have a detrimental impact on your business, as well as your short- and long-term financial affairs, consider the protection offered by an individual disability income insurance policy.
When purchasing disability income insurance, it is important to examine the following policy features:
• The policy’s definition of disability—A favorable contract will define disability based on your inability to perform the duties of your own occupation or be based on a general loss of income.
• A noncancelable clause—The insurance company cannot cancel your policy (making it “guaranteed renewable”) or increase your premiums.
• Partial disability payments— If you are no longer able to perform the rigors of running your business, but could return on a part-time basis or take a less demanding job elsewhere, the policy will pay benefits in proportion to your loss of earnings. (Many companies also have residual payment plans which, in effect, allow you to go back to work in any occupation, but pay a percentage of lost income based on how much you earned while disabled.)
• Future insurability— Allows the purchase of future coverage without regard to medical insurability.
• Benefits—Many contracts pay benefits to age 65 (some older policies that are still in force may pay benefits for life). However, benefits specified in your contract will depend on numerous factors, beginning with the nature of and risks associated with your occupation and your age. In addition, exclusions may be placed in a contract due to medical history.
• A reasonable waiting period—The cost of disability income insurance declines the longer you must wait before you can receive benefits. Consider your liquidity, sick pay, and any money owed to you when determining how long a waiting period you could reasonably afford. The policy’s waiting period is determined when the policy is purchased, not when a disability occurs. It is important to consult a qualified insurance professional to review your current needs and to plan a disability policy that will work for you in the event of a long-term disability. $
Business Applications of Survivorship Life
The unlimited marital deduction, which was established in 1981, has become common for married couples to use at the death of the first spouse under the premise of “simplified” estate planning. However, a potential complication may arise at the death of the second spouse. All of the remaining marital assets would be included in the gross estate of the second spouse, to be offset only by the second spouse’s estate tax exemption of $2 million in 2006.
The situation can be further compounded in estates composed largely of illiquid assets, such as a closely-held business. At the second death, how will estate taxes be paid other than by selling some assets? Moreover, no one can predict what the market might be like for selling such assets at an indefinite point in the future, an uncertainty that could have an impact on the amount of wealth ultimately passing to heirs.
Good estate planning begins with properly drafted wills, based on the objectives to be achieved. In larger estates, the use of a trust can help mitigate some of the potential problems created by using the unlimited marital deduction. However, the trust arrangement by itself may still leave a liquidity problem for an estate with assets tied to a business.
Survivorship life insurance may offer one solution to this dilemma by providing a death benefit when the second named insured dies. This complements the use of the unlimited marital deduction, which defers the estate tax to the death of the second spouse, by providing liquidity precisely when it is most needed. Although both spouses are covered, the ownership of a survivorship life policy could be structured to keep the proceeds out of the taxable estates of both spouses (e.g., by using an irrevocable life insurance trust (ILIT), or by designating an adult child as the owner). Furthermore, since the policy postpones payment until the death of the second spouse, survivorship life may have a lower premium than individual policies for each spouse.
A Typical Case
Let’s assume a closelyheld business, run by a husband and wife, has a succession plan calling for passing ownership of the business to their daughter at the death of the second parent. If the existing estate plan were to use the unlimited marital deduction, all assets (including business interests) would pass to the surviving spouse with no estate tax burden at the first death. However, as noted previously, a significant liquidity problem could arise at the death of the second spouse. If most of the estate is tied up in the family business, how can it pass intact to the daughter?
Enter survivorship life, which could provide the liquidity to help pay estate taxes, thereby ensuring a smooth transfer of business ownership to the daughter. In estate planning, it is fairly common to find several alternatives that may provide an acceptable outcome. The desired timing of asset transfers, the need for income for a surviving spouse, and the need for estate liquidity are just a few of the factors that should be evaluated in particular circumstances. Under the proper circumstances, survivorship life may be the appropriate vehicle to achieve estate planning objectives. A financial professional can help you determine if survivorship life insurance will help you meet your needs and the needs of your family.
Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. $
Risk Management: Is Your Organization Protected Against Identity Theft?
Stealing the personal information of an individual to commit fraud under his or her name is a growing crime. To safeguard the information of your staff and your clients, make a list of the information you possess. Detailing what, why, and when information is collected, as well as your steps for privacy protection can be extremely important if a security breach occurs. Here are some additional safety measures:
• Restrict access to records containing personal data. These files should be protected by a password that should change every six months.
• Collect only essential information. The more unnecessary data you possess, the greater your responsibility and liability. When data is no longer needed, promptly delete electronic files and shred paper records.
Hire Your Children and Help Them Save
Hiring your teenage children to work in your business can give your kids valuable employment experience and teach them to handle responsibility. And, if you can persuade your youngsters to deposit at least part of the money they earn in a Roth Individual Retirement Account (IRA), it can even give them a head start in saving for their future needs.
Although it is a retirement account, a Roth IRA can be opened at any age by anyone with earned income below $110,000 for single filers and $160,000 for joint filers. Contributions to a Roth IRA are nondeductible; however, earnings within the account accumulate tax free, and qualifying distributions are also tax free. Because they seldom make enough to owe tax on their income, children are usually better off with a Roth IRA than a tax-deferred traditional IRA. In 2006, your child is allowed to contribute $4,000 (or earned income, whichever is less) to a Roth IRA. This contribution limit applies until 2008, when up to $5,000 may be deposited in a Roth IRA. Thereafter, the contribution limit will increase for inflation in $500 increments.
The reward for getting an early start on saving for retirement can be substantial. Suppose your 15-yearold daughter were to use $1,000 she earned to purchase a Roth IRA. If she makes no additional contributions and the funds grow 8% annually, she will be able to withdraw over $50,000 tax free at age 65. Or suppose your 15-yearold son opens a Roth IRA and contributes $2,000 for 10 years. The estimated value of his tax-free fund balance at age 65 will exceed $700,000, if the annual growth rate is 8%.
A Roth IRA offers the greatest gains if the account is left untouched until the holder reaches the age of 59½, when money can be withdrawn tax free. If funds are taken out before age 59½, a penalty may apply. The IRS does, however, permit penalty-free Roth IRA withdrawals to pay for education or a first-time home purchase, though taxes will be levied on some types of early withdrawals.
Before you rush to open a Roth IRA for your son or daughter, there are a few issues you should consider. Bear in mind that you cannot stop your child from withdrawing money from the account whenever he or she wants after the child reaches the age of majority, which is 18 in most states. If you are uncertain about your youngster’s ability to manage money, opening an account in his or her name may not be the best choice.
You should also be aware that only taxable compensation income can be sheltered tax free in a Roth IRA. In general, paying your children for doing chores around the house does not qualify as compensation income, as this is an intrafamily transaction usually not reported to the IRS. As a business owner, however, you are permitted to hire your minor children to do certain jobs. Provided you pay your children a fair market wage for the services they perform, the money they earn would be considered compensation income and could be invested in a Roth IRA.
It is essential to keep careful records of how the money placed in a Roth IRA was earned, even if a teenager’s working arrangements were informal and he or she did not earn enough to owe income tax. Severe penalties could apply if the IRS determines that the funds deposited in a Roth IRA were not matched by compensation income.
Your toughest task may lie in convincing your adolescents to save, rather than spend, their earnings. The good news is that, even if your teenager goes out and blows his paychecks on a new cell phone and skateboard, the opportunity for tax-advantaged saving is not lost. If, for example, your son earned $2,500 over the course of the summer but spent the money, you could still contribute the amount equivalent to his taxable earnings into a Roth IRA on his behalf. $