For more on this topic, go to www.dentaleconomics.com and search using the following key words: life insurance, disability insurance, estate planning, Jim Biesterfelt.
Are your bases covered?
When it comes to business decisions in a family–owned practice, two essential elements are open communication and a strategy that considers the needs of all the owners. A key aspect of that strategy should be life and disability insurance planning.
A case in point is the Matrullo family.
“It was always our goal that I would go into practice with my father, Paul, when I finished dental school, and it's been a great decision,” says Joseph Matrullo, DMD, who joined his father's Cranston, Rhode Island, dental practice five years ago. “We communicate well and have very few management or financial disagreements. I think it has to do with trust.”
Approaching the family partnership in a businesslike way, including life and disability insurance planning, has also factored into the Matrullos' success. Father and son have a buy–sell agreement funded by life insurance; they also own disability insurance that would help pay the practice's overhead expenses if either of them became disabled.
In short, a practice should be treated as a business whether it's owned by family members or unrelated dentists, and that means covering your bases with proper insurance. Those “bases” could include:
- A succession plan funded by life and disability insurance
- Business overhead insurance to protect the practice in the event of an owner's disability
- Life insurance to provide an equitable inheritance to family members who are not owners of the practice
Funding a succession plan
When family members go into practice, an often unwritten agreement is that one partner will take over the practice at the retirement or death of the other. But operating on unwritten agreements can be a mistake, says Stephen Rickles, a nationally recognized estate planning, employee benefits, and tax attorney with the Denver law firm of Berenbaum, Weinsheink & Eason, P.C.
Rickles explains: “Let's say a daughter and father are in practice together, and Dad dies without a written succession plan in place. That leaves the daughter in a very difficult position of having to negotiate with other family members to purchase the dental practice at a time when emotions are raw. It's much more preferable to have a succession plan in writing so there's no need for negotiating. The plan can simply be implemented.”
Effective business succession plans often include a buy–sell agreement. Drafted by an attorney, a buy–sell agreement is a legally binding document that stipulates that if an owner leaves the practice because of death, disability, retirement, or another triggering event, the remaining owner(s) will buy out that owner or the owner's estate.
“It clearly lays out the succession plan so there are no misunderstandings among family members later,” Rickles says.
The money to carry out a buy–sell agreement can come from the dentists' cash flow, a bank loan, or life and disability insurance on each owner. Rickles prefers the third option.
“With insurance in place, it's much easier for the partner to assume ownership without having to worry about the pay–out,” he explains.
The insurance can be owned and paid for by either the practice or the individual partners. Rickles notes that one advantage of the latter option, called a cross–purchase arrangement, is that it avoids the issue of whether the life insurance must be included in the valuation of the dental practice for estate tax purposes.
Two family situations
When Kenneth Versman, DDS, brought his nephew Douglas Heller, DMD, into his Denver dental practice as an equal partner 15 years ago, uncle and nephew negotiated a buy–sell agreement. Dr. Versman determined that, if necessary, he could buy his nephew's share of the practice out of his cash flow, while the younger Dr. Heller opted to cover his obligation with life insurance. He asked Dr. Versman to apply for ADA term insurance, but Dr. Heller owns the policy, pays the premiums, and is the beneficiary.
By taking these steps, the insurance proceeds would stay out of Dr. Versman's estate, under current law, for purposes of calculating any estate tax due at his death, and would be received by Dr. Heller free of federal and state income tax. He would then use the insurance proceeds to buy his uncle's share of the practice from the estate.
For married couples in practice together, a buy–sell agreement may not be necessary if each dentist specifies in his or her will that the practice should go to the surviving spouse.
“Keep in mind, however, that a will can be changed at any time,” Rickles observes. “A buy–sell agreement, on the other hand, cannot be changed unless both parties agree. In general, I recommend a written succession plan for married couples just like I would for any partnership.”
Because married couples can pass unlimited assets to one another free of gift and estate taxes, they could make their share of the practice a gift or bequest, and therefore not require a funding mechanism like life insurance. The need for life insurance can still exist, however.
“In consulting with dentists about their insurance needs over the past 18 years, I've found that many married dentists practicing together have a common need for life insurance that can be more personal in nature,” says Dan Donohue, plan specialist for the ADA Insurance Plans, which are underwritten and administered by Great–West Life & Annuity Insurance Company.
For example, married dentists might use life insurance to replace lost income due to the death of a spouse, to pay off a home mortgage or practice debt, or to provide for the children's education.
Rickles adds, “From both practice continuity and estate planning standpoints, it's important to consider all the issues involved and make the appropriate provisions in the buy–sell agreement, estate planning documents, or both, to ensure that the desires of both spouses are addressed.”
Disability: another threat to business continuity
Family practices often overlook another threat to the business continuity: the disability of one of the owners. That's why disability insurance is just as important as life insurance in a buy–sell agreement; it provides a source of cash to buy out a disabled partner's share in the practice.
Another type of disability insurance to consider is business overhead insurance, which reimburses a practice for covered business expenses such as rent, payroll, and a replacement dentist, if either owner is disabled and can't work for several months. The Matrullos own business overhead insurance.
“That way, the cost of operating the practice wouldn't financially burden either my father or me,” Dr. Matrullo says.
Donohue adds, “Whether dentists are related or not, they should have business overhead insurance in an amount that covers what they are legally responsible for in terms of the monthly expenses of the practice.”
Providing an equitable inheritance
With parent–child dental practices, another consideration may be providing an equitable inheritance for the children who will not participate in the ownership of the practice. If the parent's share of the practice is purchased at fair market value by the dentist son or daughter, this issue would be moot because the sale is a business transaction. In fact, buying the practice makes it a significant asset for the parent, which in turn can benefit all the heirs.
However, if the parent makes a gift or bequest of all or part of the practice to a dentist son or daughter, the question of an equitable inheritance for siblings can arise. Assuming the parent wants to equalize the inheritances, he or she could leave other assets to these children, or purchase life insurance and name them as beneficiaries.
“Insurance is a clean, simple way to accomplish the objective of an equitable inheritance,” Rickles says.
Finally, dentists should revisit their insurance plan annually, or whenever their practices or tax laws change. Insurance should be kept up to date so it continues to meet the dentist's needs as well as the needs of his/her family member co–owner and other loved ones.
Editor's note: This article does not constitute legal, tax, or financial advice. Please seek professional input as appropriate to your situation.
Jim Biesterfelt is vice president of Group Special Accounts at Great–West Life & Annuity Insurance. Great–West underwrites and administers the ADA Insurance Plans, and is exclusive provider of ADA–sponsored life and disability insurance to ADA members andt their families. For more information, call (866) 607–5330 or go to www.insurance.ada.org.