A look at disability insurance

Employee benefits, in most cases, represent a hefty cost to employers and, very often, are neither well understood nor appreciated by employees. This column is about a little-understood, but potentially life-saving financial segment of employee benefits – group disability insurance.

Medical insurance is probably the most expensive employee benefit paid by the employer. To deal with the ever-rising cost, employers often pass part, most or all of the cost to employees. Medical insurance costs are often the pivot point in union vs. employer negotiations. But we have to have medical insurance, so it gets done.

Many employees receive some kind of life insurance benefit. Typically, they get $10,000 in coverage because that is enough to bury them. Or, they get $50,000 because that is the amount of coverage available without income tax consequences. Group life insurance in excess of $50,000 is a taxable benefit to an employee. Group life insurance is fairly cheap and often comes packaged with medical insurance benefits, so it is commonly provided as a benefit.

Among the three primary groups of insurance coverage – health, life and disability – it is disability insurance that is often omitted or misunderstood. Why is that? Good question, because disability is a lot more likely than death before retirement. It can be more financially and emotionally devastating than most medical complications and the premiums for it are relatively cheap. Then why is disability insurance so scarce?

There’s an old bromide in the insurance business that says, “Insurance is not bought; it is sold.” Medical insurance is easy to sell because it is a commodity. A salesman doesn’t have to convince an employer of the need; he just needs to get a better price. Life insurance rides the coat tails of medical and it can be cheap.

Disability insurance, on the other hand, requires selling the concept and the cost, and often must be (for smaller employers) medically underwritten, i.e., employees must pass physicals. This makes disability a “hard sell.”

If your employer is kind/smart enough to provide group disability insurance, they can provide it in two ways. One way is that the employer pays for the premium. The other is that you, the employee, pay. Which do you want?

Believe it or not, you want to pay. Why?

If the employer pays your disability insurance premiums, you pay nothing and have not received any taxable income to report to Uncle Sam. This is unlike group life insurance where you have to report as income any death benefit in excess of $50,000. That’s fine and dandy on the payment side; however, it becomes problematic should you become disabled and receive a benefit. What’s the problem?

The problem is that you must pay income tax on any group disability insurance benefit for which you did not pay the premium. Let’s put this in perspective. Assume that you are young enough to get some real leverage on a group disability income policy. For a monthly premium of $10, you will receive a monthly payment of $1,000 should you become disabled.

Let’s do the math. If instead of paying the disability insurance premiums yourself, you “let the boss pay,” you save $10 per month. However, should you become disabled and receive a monthly benefit of $1,000; you would now owe tax on $1,000.

Assume that, while working, your combined state and federal tax bracket was 40 percent. Well, you can bet that it won’t be that when you are disabled because disability income does not replace all of your income. The most (group) coverage that you can get is 60 percent of your salary. So, probably, you would no longer be in the 40 percent bracket.

Let’s say that you fall to the 30 percent bracket (Although this may sound like a “good thing,” it is not, for when it comes to income taxes, more is better). In the 30 percent bracket, you will pay $300 in tax on each $1,000 of benefit you receive. Don’t forget, that’s per month!

So here’s the deal. If your employer is paying for your group disability income insurance, consider making him an offer. Make sure he is sitting down when you tell him you want to pay the premiums. If he doesn’t provide any disability insurance benefits (and I mean long-term benefits; forget the mandatory state short-term policy), ask him to get the coverage and tell him that you and your fellow employees would “love” to pay for the premiums.

Why is disability income insurance so vital? 1) Most Americans are better prepared financially to die than to become disabled, although the chances are at least three to five times greater of a disability occurring.* 2) If you die, you are mourned and buried, but you don’t incur any more expenses. If you are disabled, not only are you not generating income, you continue to incur expenses.

Lastly, benefits from an insurance company are dependent upon the financial stability of the company, so make sure you’re dealing with a strong one.

*Source: www.soundfinancialplan.com, from the MDRT

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. Randy Neumann is a financial professional with and securities offered through LPL Financial, member FINRA/SIPC.