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In 2007, my 61 year-old mother was diagnosed with Stage 3 breast cancer. I can still remember the numbness I felt from hearing my mother struggle to keep her composure as she shared the news with me. Although I wasn’t a financial adviser at the time, I remember clearly the words that I uttered next.
“Let’s not worry about something until there’s something to worry about. We can’t control the fact that we’re in this situation now, but we’re 100% in control of what we do and the attitude that we take from this moment forward. Let’s be positive and beat this thing.”
My mom had unused vacation and sick time, accumulated unused vacation and sick time from previous years (“comp time”), Family Leave Act benefits, and a combination of short-term and long-term disability insurance. By combining and effectively coordinating these benefits, my mother was able to take a little over a year off to focus on dealing with her treatment and getting better.
I am happy to say that my mom won her two-year battle with cancer and has been cancer-free for nearly 11 years. Every time I reflect on that period, with the challenges that came along with it, it is my sincere belief that if not for the disability coverage that she had and the ability to coordinate her benefits to allow for her to fight the battle without worrying about the bills, she may not be here today for our daily talks.
Fast forward to 2020. As a CPA and financial adviser, I am a strong advocate for making sure my clients not only have disability insurance, but that they have the right amount to meet the risks they may face. With that said, there are a few things I wish my clients knew about disability insurance, including how to read the fine print, how benefits are taxed, when to get a private policy, and how much of your income is covered. I will cover all of that here.
Disability insurance: The basics
Anyone who knows me and my writing knows that I am an insurance fanatic. I often say that insurance is like an American Express card — don’t leave home without it. That goes for all types of insurance — life, disability, homeowners, auto, umbrella, etc. I often preach that insurance makes up the foundation of a sound financial plan, and to be without it jeopardizes the efficacy of the entire financial plan.
If life insurance is the Batman of policies, disability insurance is clearly Robin, or the indispensable sidekick. I emphasize “indispensable” because a working-age person (25 to 65) is six times more likely to experience a disability that puts them out of work in excess of 90 days than that person dying. Simply put, disability insurance is a must-have for workers who are financially responsible and have loved ones who depend on their income to meet their needs and financial goals.
Disability insurance is insurance that pays you a percentage of your income in the event that you become injured, become ill due to an illness, disease or affliction, or suffer from a health-related condition that requires treatment, like mental illness or a substance-use disorder. Disability insurance generally comes in two forms — short-term disability (STD) and long-term disability (LTD).
I often refer to disability as “protection for your paycheck” — as with many of your prized possessions that are protected with insurance, disability insurance protects your ability to earn a living.
Understanding the fine print
A disability policy, like any other insurance policy, is a contract. In these contracts, there are many provisions and terms that the everyday employee doesn’t pay attention to. However, when dealing with such coverage, understanding such provisions is critical to ensuring that an insured person is truly insured. Important terms and provisions include:
This is the income of the insured person prior to making a disability claim. Note that this coverage is generally limited to salary income. I will explain this further when we discuss the limits of disability insurance below.
Own occupation vs. any occupation
This provision dictates how a professional is determined to be “disabled” per the policy. Under the “own occupation” criteria, the policy will pay out benefits if a disability prevents the insured person from performing the duties that are unique to their specific profession. Conversely, per the “any occupation” criteria, the policy only pays if you cannot perform any job, not just the job for which you are specifically trained. The more specialized your occupation, the more you want a policy with an “own occupation” clause.
With respect to LTD policies, policies can range from one year to the insured’s 65th birthday. There are also variations where a policy can provide “own occupation” benefits for two years, then changes its disability criteria to “any occupation” (or an annual recertification of disability by an employer-designated physician).
Coordination with Social Security
Many policy benefits are offset by any Social Security Disability (SSDI) that the insured becomes eligible for while receiving LTD benefits. In general, SSDI becomes payable when a qualified applicant has been disabled a minimum of five months and is projected to be disabled a minimum of 12 months into the future. In projecting LTD benefits, it’s important to understand how the benefit can change with the introduction of SSDI benefits.
Taxation of benefits
In general, when it comes to group disability benefits, the taxation is straightforward — if your employers pay for your disability coverage or you pay premiums pre-tax, your benefits will be taxed as you receive them. Conversely, if you pay the premium with after-tax dollars, you will receive benefits tax-free.
Understanding taxation is important so that there aren’t any surprises when it comes time to make a claim and to project benefits when considering the nature of the disability and the length of said disability.
The limitations of your benefits
Disability insurance typically only covers salary. As many middle-level management employees and executives make less of their income from a straight salary, such professionals need to take care to pay close attention to ensure that they are adequately protected.
For example, a vice president makes $175,000 comprising $100,000 in base salary, $35,000 in equity compensation, and $40,000 in bonus. While the employee’s total compensation is $175,000, per many LTD policies, only the salary — or $100,000 — is covered in the event of a claim. So a family that consistently makes $175,000 can lose nearly 40% of its income in the event of an LTD claim. Even more if the benefits are subject to tax.
Addressing your family’s needs with enough coverage
It may be helpful to purchase a separate, private LTD policy in addition to the group insurance your company provides. Here are some of the reasons why this strategy may make sense:
- When you buy private coverage, most policies are issued with “own occupation” clauses
- You can choose the benefit term to meet your needs. So, if your group policy is only for two years, you can buy a wrap-around private policy that covers you for five years, to age 65, or even to age 70
- With private coverage, you pay with post-tax dollars, which makes the benefits tax-free when you receive them
- You can purchase LTD to be supplemental to your existing group LTD to cover the portion of your compensation that’s not salary
Sharif Muhammad, MBA, CPA, MST, CFP, is the founder and CEO of Unlimited Financial Services LLC, a certified public accounting firm in New Jersey.