Disability Insurance: Coverage Versus Real Benefits for Employers and Employees
When you start a new job and human resources hands you your new benefits booklet, which page do you turn to first? Typically, health insurance decisions are the first you need to make — which plan, whom to cover, what deductible, health savings account or not.
There’s no question that health care coverage is a concern for everyone, and insuring against unexpected medical bills is a prudent and important decision. But don’t forget that your income not only pays the premiums for health insurance, but will also be needed to cover costs that insurance won’t.
Employees say that they value their income more highly than any other resource, and like anything valuable, you need to know your options for protecting it. So turn to the disability insurance section of your benefits plan (if offered) and get the details on how to protect your income.
Income protection with disability insurance
You need to understand how your disability coverage works and what it protects. Everyone who is employed for a wage should ask (and be able to answer) these questions:
- Do I have disability insurance through my employer?
- What percentage of my income does it cover?
- Is there a maximum or cap on the amount of income covered?
- How do I become eligible for disability benefits?
- When will benefits begin?
- Who pays the premium for the disability insurance, me or my employer?
- Will the benefits I receive be taxed as ordinary income?
Typical group long-term disability (LTD) insurance plans cover 60 percent of an employee’s pre-disability earnings with a cap between $5,000 and $10,000 per month. Benefits generally start after 90 or sometimes 180 days. While definitions of disability differ from policy to policy, “the inability to perform the substantial and material duties of your regular occupation” is the kind of language you will find in many group LTD policies.
As part of a goals-based financial plan, you will need to know your take-home pay in the event of a disability, and have an understanding of how that income will be taxed. If you pay the premiums for your group LTD, you will receive benefits tax-free. If your employer pays the premiums for your group LTD coverage and does not include premium amounts as income, the disability benefits you receive are taxable to you as ordinary income.
Limitations of employer-paid group LTD
Group LTD is an exceptional employer-provided benefit and a great foundation for your personal financial plan, but you should make sure you understand the numbers.
The income replacement percentage in your group LTD contract is based on your gross income. So, say that you have a monthly income of $12,500 (30 percent tax bracket) with employer-paid premiums (which means benefits will be taxable) covering 60 percent of gross salary and a cap of $5,000 per month. With the monthly cap and taxability, $5,000 quickly becomes $3,500 per month because $1,500 in income tax would be due.
You should also consider the impact this will have on your take-home pay or net income. In this case, 60 percent is not the amount of coverage you actually receive. Instead, it more closely represents the percent of net income you would lose. Could you live with a 57 percent pay cut?
A common misconception is that expenses will go down during a period of disability. But the expenses that might decrease would be vacations, leisure activities, and other extras. Your mortgage remains, as does your children’s education, food, clothing, utilities, and transportation. You could even argue that, with the added medical attention associated with a disability, your expenses might go up. Remember, if you come off the payroll, you also lose your health insurance (you may be eligible for continuation of health coverage benefits known as COBRA) and your ability to contribute to your 401(k).
Filling the gap with individual disability insurance
One way to fill the gap created by limitations or taxability of LTD benefits is a supplemental individual disability insurance (IDI) policy. If you take data from our previous example and add an IDI policy, the desired monthly income can be reached.
In most cases, a supplemental IDI policy is paid for by the employee, so this tax-free portion restores the income replacement percentage to the intended 60 percent.
Disability insurance can also benefit employers
Direct and indirect costs of disability take a financial and psychological toll on employers as well as employees. Unscheduled absences cost employers millions of days and dollars in lost productivity, and are often due to disabling injuries and illnesses.
Properly structured group long-term and short-term disability insurance programs can help reduce the adverse effects associated with employee absences. A comprehensive benefits package is also a great tool to have when courting quality employees to your firm; job offers are often accepted or declined based on the benefits that are available.
In addition to having a comprehensive policy, employers can leverage their group LTD numbers to package a supplemental IDI program that makes sure their employees have the option of additional income protection. This can be done on a voluntary basis or as an employer-provided benefit. These multi-life plans come with competitive pricing, comprehensive coverage, and limited or no underwriting costs, so the incentive for the employee is greatly enhanced.
How we can help
If you have a group LTD policy, take a second look to confirm what it actually covers. If you discover gaps that need to be filled, consult your financial advisor or tax professional to secure the right coverage for your specific needs.