Business Owner's Disability, Buy-Sell, and Umbrella Gaps
Anika, 44, owns 50% of a $1.8 million S-corporation with her business partner, Ben, 51. She is married to Raj, 42, a stay-at-home parent; their children are 12 and 9. Anika's salary is $180,000 and the company pays her $60,000 in distributions. The business has a $500,000 term policy on each owner to fund a cross-purchase buy-sell; both policies expire when each owner turns 60. Anika's group long-term disability pays 60% of her $180,000 base salary, has a 90-day waiting period, and is taxable; the monthly maximum is $8,000. Her personal expenses are $11,500 per month. The mortgage is $380,000; the education funding goal is $200,000; liquid savings are $60,000. Raj has no life insurance. The family has a $1 million umbrella policy and a 16-year-old learner driver. Anika wants to know if she is 'fully covered.'
1. Calculate a rough life-insurance need for Anika using a needs (DIME-style) approach, stating each assumption. Does the $500,000 buy-sell policy substitute for personal coverage?
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Using a DIME-style needs analysis: debt $380,000; income replacement for 10 years at $180,000 = $1,800,000 (a seven-year assumption would be $1,260,000); education $200,000; final expenses $25,000. Total need is about $2,405,000; subtract $60,000 of liquid savings = $2,345,000. On a seven-year replacement assumption, the need is about $1,865,000. Either way, no personal life policy is mentioned, so the gap is large.
The $500,000 buy-sell policy is not a substitute. In a cross-purchase arrangement, Ben owns the policy on Anika's life and uses the proceeds to buy her shares from her estate or heirs. The family receives the purchase price for the business interest, not a $500,000 death benefit; the policy protects business continuity. Anika needs separate personal term coverage, probably $1.5–2.0 million for 20–25 years, plus a review of Raj's coverage because a stay-at-home parent's death creates childcare and household-service costs. I would also check beneficiary designations and whether any group life is portable.
2. Quantify Anika's disability gap and recommend design features for an individual policy.
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Group benefit: 60% × $180,000 = $108,000 per year, or $9,000 per month, capped at $8,000 per month and taxable. At an assumed 32% marginal rate, the after-tax benefit is about $5,440 per month. Expenses are $11,500, so the monthly gap is about $6,060, or $72,720 per year. A personal policy can help, but insurers typically limit total disability coverage to about 60% of income; with $8,000 of group coverage already in place, the individual issue limit may be only about $1,000 per month unless the group plan is reduced or the insurer uses a higher issue limit. That means the household cannot fully insure the gap and must also build a disability reserve and reduce fixed costs.
Design features: own-occupation definition, non-cancelable and guaranteed renewable, a 90-day elimination period matched to the group policy, residual or partial disability, COLA, future increase option, and benefits paid tax-free by having Anika pay premiums personally. I would compare the group definition-many group LTD plans pay any-occupation after 24 months-and consider a supplemental policy with a longer elimination period to reduce cost. The business should also consider overhead expense or key-person disability coverage.
3. Evaluate the buy-sell funding and umbrella limits. What additional risks would you flag?
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The buy-sell is underfunded. The company is worth $1.8 million, so each 50% interest is worth about $900,000, but each policy is $500,000-a $400,000 shortfall before valuation growth. The term policies expire at 60, yet Ben is 51 and may not retire at 60; if Anika dies at 61, the funding is gone. I would recommend permanent or guaranteed-renewable term to age 70, a valuation formula with a funded sinking reserve, and disability buyout funding. The cross-purchase structure also needs a written agreement that coordinates with the estate plan.
On the umbrella, $1 million is probably low for a household with a 16-year-old learner driver, a business, and a $380,000 mortgage; a serious auto claim can exceed $1 million quickly. I would model $2–3 million and require the teen to be a named driver with appropriate limits. Raj's lack of life insurance is a separate gap: even a modest $500,000–$1 million term policy would fund childcare and household services.