by Corbin J. Blackburn
How Much, How Soon, and for How Long?
Open enrollment for employee benefits rolls around each year and many individuals become very familiar with their health insurance plans while almost ignoring the group short- and long-term disability benefits plans offered to them possibly because they think that workers comp will cover them if they become disabled. Unfortunately, some employers don’t offer much in disability benefits. However, many employers provide disability benefits and offer to pay the cost at 100% for those that enroll in a plan.
Group Disability plans can pay benefits short- or long-term disabilities and offer 24-hour coverage for participants while worker’s compensation only covers work related accidents/sicknesses. A typical short-term disability plan (also referred to as STD) may pay 60% – 100% of salary (or monthly earnings) for periods ranging from 13 – 26 weeks. Typically, the long-term disability (also called LTD) benefits begin when the STD benefits have been exhausted. Another aspect of the STD plan is that it will cover salary only, excluding bonus or other incentive compensation. The purpose of the benefit is to keep the disabled employee in the same standard of living in the short term. Unless the employee pays some or all the cost of the plan the benefits when paid will be 100% taxable income- just like the salary earned when healthy (assuming the plan replaces 100% of salary).
Group LTD will usually pay benefits until the employee’s age 65 if the disability lasts that long. Two of the more important plan features to look for are the definition of covered earnings and the percentage of income replacement stated in the plan. LTD plans may only cover base salary while it’s not uncommon for plans to include bonus income as well. The range of income replacement may be from a low of 50% to as high as 67% of covered earnings. One of the reasons that the percentage of income replaced is not 100%, is that replacing a higher percentage of predisability earnings could incentivize the employee to remain on claim (also called malingering). If the employee pays some or all of the cost of the LTD plan, then some or all of the benefits when paid could be income tax free. Conversely, when the employer pays all the LTD premiums then benefits paid are 100% taxable and subject to payroll taxes during the first 6 months of claim. In the latter case, if the income replacement is 67% and the employee is in a 25% tax bracket, the net income replacement is 50% and many people do not have adequate personal savings/financial resources to fill the 67% -50% gap for a long claim period. In addition, retirement plan contributions may cease along with employer matching funds because the individual is no longer an employee due to the disability. There can be a myriad of other financial difficulties resulting from a long period of disability which can be addressed through proper planning.
There are individual disability plans available to help close the gap caused by taxation of benefits and loss of retirement funding and these plans can be adjusted to fit an individual’s personal needs. The costs will be based on factors such as occupation and job duties, annual earnings, family and health history, avocations/mode of living, tobacco/marijuana use, BMV report, as well as how much, how soon and for how long benefits are needed.
Does everyone need an individual disability plan? In the end, it depends on your personal circumstances. Take a look at the after-tax benefits you’re expected to receive from the group plan and compare that to your annual cash flow needs, while also factoring where you’re at in relation to your long-term goals. From there you can make an educated decision on how to handle this risk.
Cleveland Wealth, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.