UNDERSTANDING LONG-TERM DISABILITY INSURANCE
Long-term disability insurance (LTD) provides varying levels of income replacement in the event that you become disabled and can no longer work. This is an important building block for creating a secure financial foundation for your family.
71% of US adults do not have enough savings to replace their income for six months. If tragedy were to strike and they could no longer work, how would they make ends meet? Long-term disability insurance should be part of the answer.
Short-Term Disability Insurance vs. Long-Term Disability Insurance
Short-term disability insurance provides partial income replacement for a defined period if you are injured and unable to work. Most short-term disability plans replace 40%-60% of an employee’s income for a limited amount of time–normally between 9 and 52 weeks.
Long-term disability insurance provides replacement income if an injury prevents you from working for a long period of time. This type of insurance only kicks in after all other options (like short-term disability insurance) have been exhausted. Normally there is a waiting period (often 3-6 months) before this insurance begins to pay-out. Depending on the terms of the policy, payouts may continue until retirement age.
Fast Fact: 34.6 months is the average duration of a long-term disability claim filed in the United States.
You should think of short-term disability insurance and long-term disability as part of your risk management plan to protect your income in your wealth accumulation years.
What percentage of my income will long-term disability insurance replace?
Many employees opt-into short-term and long-term disability insurance through their employer. The group policy rates are generally less expensive and many employers offer to pay for all or a portion of the employee’s premiums as part of their benefits package.
However, if your employer does not offer this type of benefit, you may find yourself shopping for disability insurance.
Not all short-term and long-term disability insurance products are created equal. A cheaper policy might help you save money, but the lost coverage could add to your family’s stress during a difficult time.
The two main features that impact premium rates for disability insurance include the percentage of your income that is replaced and how long the replacement income will be provided in the event of an injury or illness.
We recommend looking for long-term disability insurance that replaces 60-80% of your after-tax income. If you are younger, it probably makes sense to choose a plan that will cover you until you reach retirement age. Older employees can save money by purchasing a long-term disability plan with a shorter benefit period since they are closer to retirement age. But remember, other factors (like personal health and financial security) can impact this important decision.
Your best bet is to meet with a qualified financial advisor to help you chart the best path forward to financial security.
Social Security Disability Insurance vs. Long-Term Disability Insurance
If you are injured or become ill and can no longer work, Social Security Disability Insurance (SSDI) may be another option available to you. SSDI is a government-funded disability program that you pay into through the social security taxes deducted from your paycheck.
To qualify for SSDI, you need three things:
- A qualifying permanent disability that prevents you from performing any type of work.
- A history of paying FICA Taxes.
- A prerequisite number of working years and income. This is calculated based on your age when the disabling injury or illness occurs.
The application process for SSDI can take five months. Even if you are approved more quickly, there is a waiting period before SSDI benefits begin to payout–six months from the date of your qualifying injury or illness.
SSDI is not designed to completely replace your income. The calculated benefit that you receive is called your Primary Insurance Amount (PIA). The average monthly payout is only $1,234 per month (reported January 2019).
Impact of SSDI on Long-Term Disability Insurance
Generally, it is much easier to qualify for the benefits provided by your Long-Term Disability Insurance (privately funded disability insurance). Social Security Disability Insurance (government provided disability insurance) requires you to complete a longer, more complicated application process.
LTDI is an important benefit because it may payout faster than SSDI – giving you more reliable access to funds during a difficult time.
If your Social Security Disability Insurance claim is approved, you may still receive adjusted payouts from your Long-Term Disability Insurance Policy. It’s important to fully understand the specific terms of your LTDI policy.
Generally, you can expect your SSDI monthly payout plus your adjusted LTDI payout to equal the coverage of your LTDI policy.
For example, let’s imagine that you purchased an LTDI policy that promises to replace 60% of your income in the event of a disability. If you are approved for SSDI and the amount you receive replaces 30% of your prior income, your LTDI may cover the remaining 30%–ensuring that your family receives the coverage you are entitled to through your plan.
But remember, every long-term disability insurance plan is different. It’s important to fully understand your plan’s terms and conditions before submitting a claim for SSDI.
A qualified financial advisor can help you understand your best course of action based on your specific situation.
Do I have to pay taxes on income from a Long-Term Disability Insurance policy?
If you’re wondering if your long-term disability income is taxable, the answer is: It depends on how the premiums were paid.
You do not have to pay taxes on LTDI payouts if the premiums were paid using after-tax dollars.
Most long-term disability policies purchased by individuals, instead of employers, are paid for with after-tax dollars.
If you are receiving long-term disability insurance as a benefit from your employer, you may be able to request that they pay for your policy premiums with after-tax dollars. Any changes must be made before the beginning of the plan year to impact how benefits will be treated by the IRS.h5>You will likely have to pay taxes on any income from an LTDI policy if your plan premiums were paid using pre-tax dollars.
Important LTDI Policy Terms and Features
Every LTDI policy is unique. You need to look beyond the premium costs to understand the real value of LTDI policy. In this section, we’ll look at some of the common terms and features you need to understand in order to make an informed decision for your family.
“Own Occupation” vs. “Any Occupation”
One of the important factors in choosing a Long-Term Disability Insurance policy is how the plan defines disability. There are two general terms used to describe when a policyholder is eligible for LTDI benefits:
Own Occupation: The employee may be eligible for LTDI benefits if they are unable to work in their previous position due to an injury or illness.
Any Occupation (General Disability Policy): The employee may not be eligible for LTDI benefits if they can perform a different job.
Many LTDI plans offer a mix of coverage. For example, you might have a long-term disability policy that provides coverage for “own occupation” disability for a limited timeframe (i.e. 2 years), and then provides “any occupation” disability coverage until the employee reaches retirement age.
It’s important to understand how your LTDI policy defines disability. A General Disability Policy may only provide benefits if you are unable to work in any job for which you are qualified.
A qualified financial advisor can help you understand the depth and breadth of your benefits before you need them. They will use this information to determine how to best protect your family’s financial future.
The waiting period is the time you are required to wait after your injury or illness before you can receive benefits. This can range from a few weeks to months or even years.
For example, if your LTDI policy has a 6-month waiting period, you’ll need to be disabled for six months before your policy will begin to payout.
Generally, you can reduce your premiums by choosing a plan with a longer waiting period. But remember to take your personal financial health into account.
Think about how you’ll survive if a tragedy occurs and you lose your income during the waiting period. Short-term disability insurance may be a cost-effective way to provide income during your long-term disability insurance’s waiting period.
Important: Do not wait to file your long-term disability claim. The waiting period only defines when payouts begin. It is in your best interest to file your claim as soon after an injury or illness as possible. It can take time to process your claim. You don’t want to inadvertently delay payout by waiting to file.
The benefit period is the length of time your LTDI policy will provide replacement income in the event of an illness or injury that prevents you from working.
Depending on your age, financial security and health it may be a good idea to purchase LTDI coverage that lasts until retirement age. This means that if something happens, you can count on having an income until you qualify for Social Security and can tap into retirement accounts without a penalty.
Non-Cancelable and Guaranteed Renewable
Can the insurance company raise my premium rate? Will I be able to renew my LTDI insurance when it expires? The terms “Non-Cancelable” and “Guaranteed Renewable” hold the answer.
A non-cancelable LTDI policy is one where the premiums are locked-in for the duration of your policy.
A guaranteed renewable LTDI policy can be renewed when you reach the end of your policy. Many employees choose to save money by purchasing a policy that expires after a certain period of time (often 5 years), instead of purchasing a policy that covers them until retirement age.
When your plan expires, what will happen to your rate? Will you be able to qualify for a new LTDI plan based on your health? If you can renew, but have experienced serious health issues, can you afford your new higher premium?
Non-cancelable and guaranteed renewable long-term disability policies offer you the most security. You know what your premium will be and you know that you can renew when you reach the end of your term.
Partial Disability vs. Residual Disability vs. Loss of Income Disability
Keep in mind that the specific terminology in your LTDI policy is defined by the underwriter. Always seek clarity from the insurance provider before signing up for a plan. These terms may vary from insurer to insurer and could impact your coverage.
For these terms, we’ll look at how a major insurer uses them to craft the scope and limits of their LTDI plans:
Partial Disability: If your LTDI plan uses the term partial disability, it means that in order to qualify for coverage you must be unable to perform all of the regular duties required to complete your job during the waiting period. As a result of your injury or illness, your income must have decreased by at least 20%.
Residual Disability: If your LTDI plan uses the term residual disability, it means that in order to qualify for coverage you must be unable to perform some of the regular duties required to complete your job during the waiting period. As a result of your injury or illness, your income must have decreased by at least 20%.
Loss of Income Disability: This term is used to describe an LTDI plan that offers compensation if you experience a loss of 20% or more of your income is due to an injury or illness. The insurer uses a formula to determine the total loss of income you’ve experienced and how much the insurance company will provide to supplement your ongoing income. Any loss above 75% of your income is generally considered a total disability.
Guaranteed Future Insurability
As your income increases from year-to-year, will you outgrow your LTDI policy’s coverage limits? Guaranteed Future Insurability provides a guarantee that you can purchase additional coverage to match future salary increases without going through additional medical exams.
Compensating for Inflation
Over time the value of the US dollar has decreased. This is called inflation. The problem is that $500 worth of coverage today won’t be worth the same amount in future years. In other words, you probably won’t be able to purchase the same amount of goods and services for $500 in twenty years that you can purchase with that same dollar amount today.
You can add a cost-of-living adjustment rider to your LTDI policy to help ensure that the financial support you receive in the future has the same buying power as today’s dollar.
Your insurance company wants you to get better and rejoin the workforce–it’s in their financial best interest. Therefore, many LTDI policies provide additional coverage for rehabilitation therapy. This additional coverage is designed to help you regain independence.
Some LTDI policies include a provision that you must pursue rehabilitation–to varying degrees–to continue to qualify for benefits. Consult your specific policy documentation for more details.
Work with a Qualified Wealth Management Team to Understand How Long-Term Disability Insurance Fits into Your Financial Future
The best decision you can make in the process of weighing the pros and cons of different LTDI products is to consult with a qualified wealth advisor in your area. They will help you bring your entire financial picture into focus and offer data-driven guidance to achieve financial security for you and your family.
Danny G. Michael is the founder and CEO of Satori Wealth Management, Inc. He has 20 years of experience in retirement planning working with individuals, families, and business owners.