Insurance Planning for Professionals
Lawrence B. Keller and Harry R. Wigler
2007 - Doctors, lawyers, and other professional clients of CPAs
often pay attention to their family’s life insurance needs,
but concerns about becoming disabled usually go unaddressed. Statistically,
however, a professional is far more likely to suffer a severe
disability that damages the ability to work, rather than die prematurely.
While some people have the financial resources to fund a disability
on their own, most need disability income insurance to cover the
risk. Good planning on the part of a CPA can result in peace of
mind and financial security—the perfect gift for one’s
family and other loved ones.
insurance planning has changed dramatically over the last decade.
Professionals and their financial advisors have demanded more
flexibility when structuring disability policies. The insurance
industry has responded by offering myriad options. Now more than
ever, CPAs can help clients protect their most valuable asset—the
ability to earn an income. This is one area where what applies
to all professionals also applies to CPAs themselves and to their
Policies Are Offered
insurance can be purchased on an individual or group basis. Group
insurance is usually provided by an employer or purchased individually
through a sponsoring professional association. Although initially
low in cost, and a reasonable alternative for some professionals,
such group policies do not provide the customized benefits that
can be achieved through quality individual policies.
can be canceled (by the sponsoring association or the insurance
company), rates increase with age, and premiums are subject to
adjustments based on the claims experience of the group. In addition,
group and association contracts often contain more restrictive
definitions of disability as well as less generous contract provisions
when compared to well-structured individual policies. On the other
hand, they are initially far less expensive than individual policies.
companies will issue disability insurance coverage equal to approximately
60% of earned income. Certain occupations, however, are provided
with “special limits.” The limits permit new professionals
to purchase benefits in excess of what their current earnings
would normally allow. The most common maximum monthly benefit
available to professionals is $15,000. However, some companies,
depending on occupation, may allow a professional to purchase
up to $20,000 in coverage combined with group long-term disability
(LTD) insurance provided by the professional’s employer.
of Disability Insurance
are based on factors such as the insurerd’s age, gender,
monthly benefit, optional riders, and the occupational classification
that the insurance company assigns to each profession. As a general
rule, the younger the policy owner, the lower the cost. Professionals
should purchase a policy as early in one’s career as possible
to lock in lower premium rates.
women are better risks for life insurance, this does not hold
for disability insurance. Rates for females are substantially
higher, and their policies can cost 50% to 75% more than policies
for men. Unisex rates may be available by taking advantage of
a “multilife” discount. This
arrangement typically requires that three or more policies be
purchased by individuals employed at the same law firm, medical
practice, or other professional firm. While this strategy allows
females to save as much as 50% on the cost of their policies,
males’ rates may actually increase. One must consider any
potential savings against the overall makeup of the individuals
to be insured.
classification assigned to a profession or medical specialty by
the insurance company will significantly impact premium rates,
as well as the policy provisions made available to the insured.
The classifications are generally based on the insurer’s
claims experience. Professionals such as CPAs and attorneys generally
qualify for the highest occupational classification, and therefore
pay the lowest premium. On the other hand, physicians qualify
for a lower classification and therefore pay higher premiums.
to Look for in a Disability Policy
provision. The renewability provision is a key feature
of an individual disability income insurance policy. The provision
defines an insured’s rights when it comes to keeping the
disability policy in force. In general, a disability policy can
be guaranteed renewable only, or both noncancellable and guaranteed
renewable. If a policy is guaranteed renewable only, the
insurance company cannot cancel or change any provisions of the
policy as long as the insured continues to pay premiums. In the
event of poor claims experience, however, the insurance company
does reserve the right to increase premiums, with state approval,
for an entire class of policies.
and guaranteed renewable. If a policy is both noncancellable
and guaranteed renewable, the insurance company cannot cancel,
change provisions, or increase the premiums for the life of the
policy. Such a policy is preferable because it provides insureds
with an added level of security.
the definition of total disability is the most important aspect
of a disability policy. Professionals must pay careful attention
to the definition of disability found in their policies because
it ultimately determines how any claim for benefits will be judged.
There are three definitions of “disability” commonly
found in the insurance industry, with significant differences
(also known as “true” or “pure” own-occupation)
is the most liberal definition of total disability available.
It pays benefits if one is “not able to perform the material
and substantial duties of [one’s] occupation.” An
insured would collect full disability benefits if he could no
longer work in his occupation, even if he decided to transition
into another occupation, earning the same or more income prior
“own-occupation” has become the most prevalent type
of disability policy in the insurance industry and typically pays
benefits if an insured is “unable to perform the substantial
and material duties of your occupation and not working”
(emphasis added). Although benefits are still contingent upon
the insured’s ability to work in an occupation, this definition
will not allow an insured to continue receiving full disability
benefits if working in another occupation.
occupation” is the most restrictive definition of the three
and is often found in group or association policies. Under this
definition, an insured is eligible to receive benefits only if
found to be “unable to work in any occupation which you
are reasonably suited to by your education, training or experience.”
Unfortunately, this determination is made by the insurance company,
and professionals—being generally well-educated and well-trained—will
find it very difficult to collect benefits under this type of
disability rider. Unless a policy contains a residual
disability rider, insureds may have to be totally disabled to
collect any benefits. While an “own-occupation” policy
protects an insured’s ability to work in his occupation,
it may not sufficiently protect the insured’s income level.
Many disabilities might allow someone to continue working in his
occupation, albeit on a limited basis while suffering a loss of
income. Adding a residual disability rider to the policy would
allow a disabled person to continue receiving benefits proportionate
to the loss of income if he returned to his occupation on a part-time
with policies such as modified “own-occupation” or
“any occupation,” a residual disability rider might
allow an insured to continue receiving benefits if working in
another occupation, or if the insurance company determined that
the insured could work in another “reasonable” occupation
with reduced earnings. Generally, to qualify for residual disability
benefits, one must experience an income loss of 20% or more (as
compared to pre-disability earnings). Additionally, if the loss
of earnings is greater than 75% or 80%, then, depending upon the
rider’s provisions, 100% of the monthly disability benefit
might be paid.
professionals and service providers whose incomes are based solely
on the number of clients or patients that they see must understand
how recovery benefits work. While some policies have an unlimited
recovery benefit built into the residual disability rider, others
make the recovery benefit available as a separate rider.
the example of a small-firm lawyer whose income is based solely
on the business generated and number of documents prepared. She
had been totally disabled for one year and after a full recovery
she has returned to the firm. Her physician has stated that she
can perform all of her job duties and work the same number of
hours as before.
that had depended on the lawyer for legal advice and document
preparation have gone elsewhere. Additionally, referral sources
with whom she had built relationships had no choice but to refer
clients elsewhere. Obviously, it would be very difficult to take
the business away from the practitioner or firm that had been
providing these services during another lawyer’s disability.
As a result,
rebuilding a practice and income level might take years. Without
a recovery benefit, she would no longer qualify to collect any
benefits at all. With an unlimited recovery benefit, however,
the lawyer would continue to receive benefits until her income
reached 81% or more of her pre-disability income. For a self-employed
individual this can mean the difference between surviving financially
of living adjustment (COLA) rider. A COLA rider
is designed to help an insured’s benefits keep pace with
inflation after a disability has lasted for 12 months. The adjustment
can be a flat percentage, or tied to the consumer price index
(CPI). Ideally an insured wants a COLA that is adjusted annually
on a compound-interest basis with a “catch-up” feature
and no cap on the monthly benefit. This rider is important, but
if reducing the cost of coverage is an issue, professionals should
consider excluding it from a policy because it is expensive and
would be a significant benefit only when a disability lasts several
years. Because one cannot predict or choose the length of a disability,
excluding this provision might also be risky.
increase option rider. This rider is important for
young professionals. It offers the ability to increase an insured’s
disability coverage, regardless of future health, as income rises.
It is important to know when coverage can be increased, as well
as by what increments, on any given option date. Some companies
may allow an insured to use the entire option in one year as long
as the insured’s current income warrants the increase; others,
however, may limit the amount that can be purchased based upon
the original monthly benefit in place when the policy was purchased.
implications. According to IRC section 104(a)(3),
personal disability insurance benefits are received free of income
tax, provided premiums are paid with post-tax dollars. If an employer
provides coverage and takes a tax deduction for the premiums paid
on the insured employee’s behalf, however, the benefits
are taxable when received. This means that an employee could lose
as much as half of the benefits when they are most needed. A better
alternative would be for the employee to forego the tax deduction,
or for the employer to give the employee an annual bonus equal
to the policy’s premium. The employee will owe taxes on
the bonus, but the employer will retain its tax deduction, and
the insured employee’s benefits remain untaxed.
disability rider. This relatively new rider, also
called a CAT rider, was introduced by many insurance companies
to pay additional benefits if an insured is unable to perform
two or more activities of daily living (ADL) without human standby
assistance, or if the insured suffers a cognitive impairment or
an irrevocable disability. The ADLs are bathing, dressing, eating,
transferring, toileting, and continence. This same definition
of disability is found in a long-term care insurance policy. The
CAT rider works well when the insured has already reached the
maximum benefit level in traditional insurance policies and is
still looking for relatively inexpensive ways to supplement coverage.
example of a young professional who loses both legs in a car accident.
He would meet the definition of disability because he would be
unable to perform the material and substantial duties of his occupation
or is considered presumptively disabled. However, he does not
require a physician or other skilled healthcare provider to take
care of him—he simply needs help performing ADLs. As a result,
this would not be covered by health insurance. The additional
benefits of a CAT rider would pay for the cost of the caregiver
and preserve the value of the insured’s disability benefits
to meet monthly expenses. Generally, this rider can provide up
to $8,000 month in benefits, not to exceed 100% of the insured’s
prior monthly income, in addition to the monthly disability benefits
under the policy.
the $15,000 maximum monthly benefit. Someone who
has an old policy with a future purchase option rider might be
subject to the rules that applied at the time the policy was purchased.
In such a case, the insured might be able to purchase coverage
in excess of $15,000 per month. Other possibilities might be to
supplement an existing individual policy with a group disability
policy or to purchase additional disability policies that protect
the insured’s retirement plan contributions, overhead expenses,
or ownership interest in a practice.
Long-Term Disability Insurance
whose employer makes group LTD insurance available, or who is
changing employers, may have the opportunity to supplement individual
disability insurance coverage. Once purchased, an individual policy
would not be affected by subsequently enrolling in a group LTD
plan. If, however, an individual policy is not already at its
maximum benefit level, this strategy might prohibit the insured
from increasing an individual policy further.
Insurance Protection for Retirement Plan Contributions
individually owned disability insurance plans traditionally are
designed only to replace a portion of the insured’s current
income, not to replace monthly contributions into company or individual
defined-contribution (DC) retirement plans. Nevertheless, a few
disability insurers have developed programs designed specifically
to replace lost retirement savings.
effective approach uses an individual disability insurance policy
that pays benefits into a trust set up specifically for the insured’s
benefit. If a disability occurs, monthly benefits are paid directly
into the trust. The trustee, with input from the disabled individual,
then invests the money in mutual funds or individual securities
until the insured (the trust beneficiary) reaches age 65. At that
point, the trust’s assets are distributed to the individual
to provide supplemental income for retirement.
and trust earnings are subject to the normal rules that govern
the taxation of trusts and individual disability income insurance.
Trust earnings are generally taxable to the insured as the beneficiary
of the trust. As noted above, disability insurance policy benefits
may be taxable or tax-free, depending on who paid the premiums.
Professional Practices and the Professionals
overhead expense insurance. A professional in public
practice, responsible for some or all of the monthly expenses
required to keep an office open, should consider purchasing a
business overhead expense (BOE) policy in addition to a personal
disability policy. A BOE policy provides reimbursement for the
expenses of operating a practice if one of the practice owners
is sick or hurt and cannot work. These expenses may include staff
salaries, rent or mortgage payments, utility bills, professional
liability insurance premiums, and other fixed costs normal to
the operation of a professional practice. In addition, some policies
may even provide benefits for disabled professionals to hire a
temporary replacement to fill in during a disability. This way,
the practice’s expenses are covered until the disabled partner
returns to the practice or until the disabled partner’s
share in the practice can be sold. Premium payments for BOE insurance
are tax-deductible as a reasonable and necessary business expense
(Revenue Ruling 55-264, 1955-1 C.B. 11). Benefits received during
disability, while taxable upon receipt, are used to pay practice-related
expenses, which are tax-deductible. As such, the net tax result
is a wash.
buyout insurance. Partners in a firm will also want
to consider a policy known as disability buyout (DBO) insurance,
which is designed to help provide funds toward the purchase of
a disabled partner’s ownership interest if, due to a lengthy
disability, the individual is no longer capable of being a productive
member of the practice.
Due to the
specific skills each individual brings to a practice, attorneys
often recommend a buy-sell agreement that details what is to occur
upon the death, disability, or retirement of each partner/owner.
Having a proper buy-sell agreement in place before disability
occurs can avoid the hard feelings and the conflicts of interest
that often result from a partner’s disability. The agreement
should set forth the purchase price to be paid or should provide
a formula for determining the price. Perhaps most important, the
agreement must have a mechanism for providing the funds needed
to make the purchase.
in conjunction with a disabled partner’s individual disability
income insurance and BOE insurance, a DBO policy will allow the
business to continue to generate an income for the healthy partners,
while a disabled partner is supported by the benefits from an
individual disability policy. Any continuing share of business
expenses is reimbursed by the disabled partner’s BOE policy
until the buyout is in effect. Premiums paid for DBO policies
are never tax-deductible, whether paid by corporations, partnerships,
or individuals. The benefits, therefore, would not be subject
high-quality disability insurance has never been easy. Although
the additional options available today create more flexibility,
they also mean that the individual disability insurance marketplace
has become even more complicated for professionals. Policies vary
greatly in terms of the quality of the insurer, definitions offered,
maximum benefit limits, and premium rates. It is more important
than ever for professionals to take the time to compare the contractual
provisions of the policies under consideration and to understand
how and why they differ. The best approach for a CPA is to employ
the services of a professional insurance agent or financial planner
who specializes in working with CPAs and CPA firms. Such an individual
will be familiar with which companies’ policies are best-suited
to the needs of a particular firm’s professionals.
B. Keller, CLU, ChFC, CFP, is the founder of Physician
Financial Services, a firm specializing in income protection and
wealth accumulation strategies for physicians. He can be reached
Harry R. Wigler, CPA/PFS, specializes in tax and
financial planning for professionals and small business owners.
He can be reached at Harry@hrwcpa.com.