The Ultimate Disability Insurance Plan for Small Business Owners

Qualified Sick Pay Plans: The Ultimate Disability Insurance Plan for Small Business Owners

No agent, and no insurance company, can declare himself or herself a professional in the disability insurance market if he or she is unfamiliar with Qualified Sick Pay Plans.  For small business owners, this is the ultimate in CYA planning to ensure their earnings don't go bust, and it's yet one more way for business owners attract and retain talented employees who contribute greatly to the bottom line.

We'll Start with the Problem

Let's say we have a small business owner, we'll call her Abbey.  Abbey owns several small shops that sell tobacco products (fine cigars and such) and one day we ask Abbey a very important question about her plans to continue her income if she were to become sick or injured and couldn't work.  Abbey confirms her plans to continue to use the company's payroll to ensure that she receives her checks in order to continue her and her family's life style (it is after all, her business).

The problem, however, is that unless Abbey has this plan outlined in writing, cutting herself a check on payday from payroll when she's not working is most likely illegal (definitely if she's deducting the expense).

So, Abbey would most likely need to pay taxes both as income to herself, and her company would be unable to deduct the expense (i.e. would pay taxes on the money as well).  Deducting the expense and/or not reporting the income herself could create a serious tax violation.

The same would be true for any employee.  Though it would be odd for Abbey to want to provide this benefit to any rank-file employee, it's certainly reasonable for her to wish to continue the income of a key employee if he or she were unable to work due to injury or sickness.

Enter Qualified Sick Pay Plans

Though this is a subject talked about mostly by agents and brokers who have a mastery in the disability insurance market, Qualified Sick Pay Plans have nothing to do with insurance in and of themselves.  They are legal documents that stipulate a company's intention to continue compensation for certain employees if they are unable to work due to injury or illness.

Depending on business structure and design of the plan, premiums can be tax deductible (if desired) and the employee can recognize the premium as a bonus and pay taxes on it or they can pay taxes on the benefit.  The specific details can become a little complex and go beyond the scope of this article, but if you're looking for more, feel free to drop us a line.

Who Gets Covered Under the Plan?

The word “qualified” in Qualified Sick Pay Plans is not used like it is in an ERISA compliant plan (where it essentially means everyone and not to the extend that it favors certain employees over other).  Here, qualified merely means that it is the company's official plan to continue income for certain employees.  This means the company can “carve-out” employees that it wants to give this benefit.

This also means that Qualified Sick Pay Plans can be used a a recruiting and retention tool.  Abbey can choose to extend the benefits of her plan to her CFO, and her VP of purchasing, but doesn't need to offer the benefit to every person under her employment.  She can choose to cover everyone else with a basic group disability insurance policy, or choose to offer no disability coverage for everyone else.

The carve out itself is pretty wide in terms of who can be covered and who can be excluded.

For example, if Abbey has a VP of Marketing who is fairly new and Abbey's not sure its going to work out she can exclude this individual from the plan if she chooses.

The Other Problem: How Disability Insurance Comes into Play

There are two ways to fund a Qualified Sick Pay Plan:

  1. Self Fund
  2. Fund with Disability Insurance

Self Funding a Qualified Sick Pay Plan

If Abbey chooses to self fund the plan she merely plans to use money from the company to provide for the benefits promised in the Qualified Sick Pay Plan.  So, if someone goes on claim, she'll simply cut the check required from the plan to the covered individual from company assets.

Not a huge production, but there is a serious consequence Abbey needs to address  immediately upon adoption of her plan.

The Financial Accounting Standards Board (FASB) established FAS 112 in 1992, this pronouncement (as they are called) modified earlier FASB Statements to outline how businesses must account the planned payment of benefits on their balance sheets.

Essentially, FAS 112 requires business to report the Net Present Value of all benefits (i.e. all potential payments for all covered employees) required under the Qualified Sick Pay Plan.  This could create several hundred thousand dollars (possibly even a few million) in new liabilities to instantly appear on the company's balance sheet, generally a very unattractive concept.

Funding a Qualified Sick Pay Plan with Disability Insurance

To avoid the realized liability, a company can simply move the liability off its books by paying an insurance company to retain the risk.  This is done by purchasing disability insurance on each covered employee to ensure the promised income continuation is paid.

So, if the employee is out of work due to injury or illness, the disability insurance policy does exactly what it's designed to do (pay them money) and the company's obligations under the Qualified Sick Pay Plan are met without the liability landing on its balance sheet.

The type of disability insurance used is really up to the the owner or the company.  Individual policies can be purchased, multi-life policies are frequently used, and even a group policy can cover the obligation (though due to their limitations, this is rare).

Pretty Simple

Qualified Sick Pay Plans are a powerful tool for small business owners to ensure both their own income and the incomes of their key employees continues and is a benefit afforded to them by the company.  There is some careful planning that needs to be address concerning funding, and most small businesses opt to fund these plans with disability insurance, making this concept an important one among knowledgeable disability insurance focused agents/brokers.

About the Author Brandon Roberts

Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.

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