Long Term Disability: Big Value, Little Appreciation

The thing about insurance is that it can feel like an unnecessary cost – until you need it. For coverage of big-ticket expenses, like everything your regular income pays for, it can become the most valuable type of insurance you can carry. Perspective generally depends on one's needs, and needs can change overnight.

Long term disability (LTD) insurance, for example, lacks the pizazz and novelty of say, pet insurance or free worksite massages. However, LTD is more akin in value to health insurance in that it is a critical benefit when needed.

According to the Social Security Administration, 25 percent of the adult population will experience some form of disability between the ages of 20 and 67. Note that this age range encompasses working age years before full entitlement retirement age.

Critical Safety Net
If a worker becomes severely incapacitated to the point of being unable to work for several months, it is very likely that his household income would suffer considerably. Not many workers in America have enough savings to support them for months on end. In fact, a study by the Federal Reserve Board revealed that more than half (53 percent) of US households do not have enough emergency funds saved to cover three months without income. Worse yet, nearly half (46 percent) of the study's participants said they didn't have as much as $400 in cash to cover a sudden emergency expense.

Many workers do not appreciate the value of income replacement. They figure that if they become ill or injured, their health insurance plan is adequate to cover their expenses without significant out-of-pocket spending. However, what they don't consider is how they will pay their bills if they are out of work so long that they use up any available paid time off and short-term disability (STD) coverage paid for by their employer or themselves.

How Disability Insurance Works
When a worker first becomes disabled due to accident, injury or illness, he may need to use paid time off benefits until any available STD policy kicks in. The typical wait period for STD is up to seven days. STD initially replaces close to 100 percent of wages for a period of time, but payouts may be reduced the longer the beneficiary is out of work – to as low as 60 percent. Length of coverage and payment percentages vary by plan.

If the worker has an employer-sponsored LTD policy, it is generally coordinated to begin coverage once his STD policy terminates. STD usually covers up to 90 days while LTD typically has a three to six month wait period. A sample LTD plan might provide 50 to 70 percent of wages over a certain time period, such as five or ten years. Some policies may continue paying out until age 65. The average duration of LTD claims is close to three years, according to the Council for Disability Awareness.

Who Pays For LTD?
All workers who pay FICA (payroll) taxes are eligible for disability benefits via national Social Security Disability Insurance (SSDI), which is a sister program to Social Security retirement benefits. However, just because you are eligible doesn't mean you will qualify for benefits. The SSDI qualification process is notoriously difficult. The applicant must be unable to work at any job and have been totally disabled for at least five months. Even then, the actual disability is highly scrutinized.

For example, amputation of one hand does not qualify (even for a carpenter). One must have had both hands amputated or one hand and one leg above the ankle. The federal government program considers only the extent of the disability itself; it does not take into consideration how the disability was incurred or the profession of the beneficiary.

Five states (California, Hawaii, New Jersey, New York, Rhode Island) and Puerto Rico have State Disability Insurance programs that are funded through state income taxes. Most range from 26 to 30 weeks for disability benefits; California leads the pack with 52 weeks.

According to LIMRA, 41 percent of US employers offer long term disability insurance – although most of them are large employers. Annual premiums are generally about $300 per individual policy. Many employers pay for a basic benefit that replaces 40 or 50 percent of income, but then may offer workers the opportunity to purchase a higher level of income replacement at group discount rates. LTD is increasingly being offered as a "voluntary" benefit, meaning that employees pay the entire premium. Workers can expect to pay one to four percent of their annual wages for a policy.

Be aware that some group policies place limits on coverage. Therefore, workers with higher salaries may be under-insured relative to their income replacement percentage.

Also note that whatever portion of the premium is covered by the employer triggers an income tax on the correlating benefit. However, if workers elect to pay for LTD on their own with post-tax wages, they will not have to pay income taxes on the payouts. This can represent a significant cost savings should the worker receive benefits for years. He would basically receive tax-free income.

One key factor is that employer-sponsored LTD policies may not be portable; they can terminate at the end of the month that a worker leaves the company. If, on the other hand, he purchased his policy on the individual market, it belongs to him no matter where he works.

Auto Enrollment
It is in an employer's best interest to encourage large numbers of workers to enroll in an employer-sponsored LTD plan in order to reduce the group premium. This and the fact that LTD is not a particularly popular or understood plan is why many employers cover the cost of it as a value-added benefit.
One way they do this is by automatically enrolling new hires, giving them the ability to proactively opt out. This may be an important tactic for smaller employers, since insurers typically require a minimum number of workers to offer a plan. Recent studies have found that employers who deploy auto-enrollment in voluntary long-term disability plans tend to boost participation up to 75 percent, versus 30 percent by employers who leave the decision solely up to workers.

Another reason it is best to enroll workers in an LTD plan when they are initially hired is because insurers are increasingly requiring workers to present "evidence of insurability" during a subsequent open enrollment period. This means they may have to answer medical questions before they can be approved and may even be subject to pre-existing condition exclusions – meaning they will not qualify for income replacement (or the payouts may be delayed or time-limited) for claims related to that existing disability.

Overall, the little-understood benefit of an LTD policy is that it can be a (financial) life saver. Whether an employer intends to pay the full premium or offer it as a voluntary benefit (for which the tax advantage can be superior), it pays to educate workers on the value of long-term disability insurance.

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