Your Guide To Navigating Employee Benefits: Disability Insurance

June 24th, 2024 by Blake Pinyan

Disability insurance is a crucial employee benefit offered by many large employers. Similar to life insurance, which helps ease the financial burden caused by a death, disability insurance aims to alleviate loss of earnings due to a disability.

This article explores:

• What disability insurance is
• Why it’s needed
• Who needs it the most
• How taxes are applied to benefits
• How employers typically offer it
• What to consider when making your choice

Understanding Disability Insurance

Disability insurance provides a financial payout if you become disabled and cannot perform the same duties you were able to before the disability. Policies are generally categorized as either “Own Occupation” or “Any Occupation” for claim payouts.

• Own Occupation: Under this standard, you are considered disabled if you cannot perform the essential duties of the specific job you were working at the time of the disability. Claims require evidence specific to the job requirements, such as physical limitations. For example, a warehouse worker who loses an arm due to an accident would need to show they cannot perform their specific duties. The insurance company will verify this through medical records and doctor certifications.

If your claim proves you cannot perform your pre-injury job’s duties, you will receive benefits regardless of whether you work elsewhere. This is significant because, under this definition, you can technically receive disability benefits while working in an unrelated field.

For instance, the warehouse worker could transition to a consulting role where their arm is not needed and still receive full benefits. Their total disability benefit wouldn’t be impacted by their new earnings. However, such policies tend to be more expensive due to the less strict payout requirements.

Insurance carriers base Own Occupation policies on how an average employee in the national economy would perform the role, not on an individual’s specific abilities. This could lead to denied claims if the carrier believes the role can be performed by an average employee with a personalized disability, such as something cognitive.

Typically, most disability plans start with Own Occupation coverage and then transition to Any Occupation after benefits are paid for a few years.

• Any Occupation: This definition is stricter and more difficult to meet compared to Own Occupation. A person is considered disabled under Any Occupation if they are unable to perform the essential duties of any job they are reasonably qualified for, not just their previous role. The coverage applies when you are unable to work in any job suitable for your education, experience, and age. Therefore, the policy won’t pay out if you can still work.

For example, the warehouse worker who lost their arm wouldn’t be paid benefits under the Any Occupation standard if they could become a consultant. However, if the lost arm prevents them from performing any other job they are qualified for, they could receive Any Occupation benefits.

Before paying out money, insurance companies evaluate your salary and disability history, as well as analyze whether you could perform similar available occupations. This vocational analysis can become complicated, as it involves determining transferable skills, available jobs, and working within your limitations.

Compared to Own Occupation policies, Any Occupation generally has lower premiums because the payout requirement is much stricter. Lower payouts translate to lower premiums for the carrier. Conversely, Own Occupation policies are more expensive because the payout requirements are less strict and more claims are paid.

The broad nature of Any Occupation policies makes them harder to receive payouts. Essentially, under Any Occupation, you need to argue that you’re too incapacitated to work in nearly any full or part-time job in the economy, which is a tougher case to make.

Who Needs Disability Insurance The Most?

Similar to life insurance, disability insurance caters to specific groups of individuals who face a higher risk of financial hardship due to disability. Here’s a breakdown of those who could benefit most from this coverage:

• Individuals in Physically Demanding or Specialized Jobs: Construction workers, nurses, physical therapists, and surgeons are all examples of professions with a higher risk of injuries or illnesses that could prevent them from performing their duties. Workers’ compensation might offer some relief for work-related injuries, but disability insurance provides a broader safety net.
  • For instance, a warehouse worker who relies on their physical strength to lift boxes may be unable to work after a disabling injury. While workers’ compensation might help in the short term, disability insurance would provide crucial financial support in the long run.
• Individuals with Frequent Injuries or Illnesses: People with chronic health conditions or those who experience frequent injuries are more likely to miss work for extended periods. Disability insurance helps bridge the financial gap during these times, allowing them to focus on recovery without the added stress of financial insecurity.
  • Common examples include individuals with back problems, repetitive strain injuries, or chronic diseases. Disability insurance policies can offer financial assistance while they recover from medical issues.
• Those Who Financially Support Others: Disability insurance is especially important for primary breadwinners, such as parents with young children. Even if the worker becomes disabled, their family still relies on a steady income to cover basic necessities like food, clothing, and shelter.
  • In single-income households, disability insurance becomes even more crucial. If the sole provider can’t work due to a disability, the entire family’s financial stability is at risk. Disability insurance helps ensure they can weather such a storm.
• Business Owners and Key Employees: The success of many businesses hinges on the expertise and contributions of key individuals like owners or highly skilled employees. A disability impacting these individuals could have a ripple effect, harming both the business and its employees who rely on their income.
  • Disability insurance for business owners and key employees safeguards their financial well-being in case of disability. This, in turn, helps protect the business from financial collapse and ensures continued employment for its workforce.

Taxation of Disability Payments

Understanding how taxes apply to your disability benefits depends on who paid the premiums for your policy. Here’s a breakdown:

• Employer-Paid Premiums: If your employer covered the entire premium cost, any benefits you receive are considered taxable income. You’ll need to report them on your tax return just like regular wages.
• Employee-Paid Premiums: If you paid the full premium amount with after-tax dollars (money you’ve already paid taxes on), the benefits you receive are generally tax-free.
• Shared Premiums: If both you and your employer contributed to the premiums, the taxation follows a proportional split. The portion of the premium you paid is considered the non-taxable portion of your benefits, while the employer-funded portion is taxed as income. For example, if you paid 20% of the premium and your employer paid 80%, then 20% of your benefits would be tax-free, and the remaining 80% would be taxable.

Understanding Your Employer-Sponsored Disability Insurance

When evaluating your employer-offered disability insurance, consider these key factors:

• Cost: Does your employer fully sponsor the premium, or will it be deducted from your paycheck? Knowing this upfront helps you budget for the cost of coverage.
• Policy Details: Disability insurance typically comes in two parts: Short-term and Long-term.
  • Short-Term Disability: This coverage kicks in first and provides a portion of your income for a limited specified period if you experience a short-term illness or injury.
  • Long-Term Disability: If your disability persists beyond the short-term period, long-term coverage takes over. It can pay benefits for a much longer duration, potentially until you reach your full retirement age.
• Benefit Details: There are several key terms to understand regarding your benefit payouts:
  • Benefit Period: This refers to the total timeframe during which you will receive benefits, with shorter periods for short-term and longer periods for long-term policies.
  • Elimination Period: This is the waiting time before you start receiving benefits after a disability. A shorter elimination period is preferable as it minimizes the time you go without income.
  • Benefit Amount: This is the percentage of your pre-disability salary you will receive as benefits. It’s typically not 100%, so having an emergency fund is crucial to bridge the gap.
  • Maximum Benefit Amount: This is the highest amount the policy will pay out, typically expressed as a weekly or monthly maximum.

Example Breakdown:

Let’s say your employer’s benefits summary reads:

• Short-Term Disability: Takes effect on the 8th day (elimination period) for illness or injury and pays 60% of your weekly salary (up to $2,500) for a maximum of 26 weeks (benefit period).
• Long-Term Disability: Pays 60% of your salary (up to $15,000 per month) until you reach your full retirement age or are no longer disabled (benefit period).

By understanding these components, you can make informed decisions about your disability coverage and its potential impact on your finances in case of an unexpected disability.

Considerations

When evaluating disability insurance, two main factors come into play: cost and portability.

• Cost:
  • Employer-Sponsored Plans: With employer-provided disability insurance, you typically don’t have much choice in the benefit amount. It’s usually a set percentage of your income, and you can’t opt for a higher payout. However, these plans offer significant advantages:
    • Guaranteed Issue: Enrollment is automatic with little to no medical underwriting, meaning pre-existing conditions won’t disqualify you.
    • Lower Cost: Employers often subsidize the cost partially or fully, making them more affordable than individual plans.
  • Individual Plans: These plans offer more flexibility in choosing your benefit amount, but you’ll need to undergo medical underwriting, which can affect your approval or premium cost. Individual plans also tend to be more expensive as you don’t benefit from employer contributions.
  • Cost Factors: Several factors can influence your premium:
    • Age: Younger individuals generally pay lower premiums.
    • Occupation: High-risk jobs like construction will have higher premiums than desk jobs.
    • Elimination Period: Choosing a longer wait time before benefits kick in lowers your premium.
  • Affordability: If your employer doesn’t cover the cost, evaluate your budget. Can you comfortably manage the premium deduction alongside other expenses? If so, disability insurance is a wise investment to protect your income in case of disability.
• Portability: Group disability plans offered by employers are not portable. This means the coverage ends when you leave the company. Consider this if you plan to change jobs:
  • Job Change: If your new employer doesn’t offer a group plan, you might be left without coverage.
  • Individual Plans: An individual disability plan can provide a safety net in such situations. While more expensive, these plans can offer better benefits tailored to your specific needs and health status. This can be especially valuable for young and healthy individuals.

Conclusion

Disability insurance is a cornerstone of financial security, offering a critical safety net if illness or injury prevents you from working. Employer-sponsored plans are attractive due to their affordability and guaranteed coverage. However, consider their lack of portability if you plan to change jobs. Individual plans offer more flexibility and may be particularly beneficial for young, healthy individuals.

Regardless of your choice, a thorough evaluation of your disability coverage is crucial. This proactive step grants you peace of mind and safeguards your earning potential in the face of the unexpected. At Anchor Bay, we’re here to help you navigate this process and ensure you have the right protection in place.