When you hear the term ‘underinsurance,’ do you understand what it means?
By Bob Herum, Second Vice President, DI & GSI Sales, Ameritas
I picture the millions of working Americans who are employed, receive benefits through their employers, and yet, go about their daily activities without realizing the potential financial risk to their way of life. Specifically, I’m thinking of their income and what insurance they may have in place if they were hurt or became too sick to work—even for a few months.
Most working Americans depend on their income to pay their bills, yet few prepare for the devastating financial impact caused by temporary (or longer-term) illnesses and injuries. A third of employers in the U.S.—particularly large ones—provide a group long-term disability plan, however, few employees could describe the group plan they have through work or what it covers. Many workers assume the insurance they have through work or from social programs, like Social Security Disability Income insurance or worker’s compensation, will be sufficient if the need arises. Unfortunately, reality is likely much different.
Let’s consider an employee with traditional group long-term disability coverage through work. The employer usually pays some or all of the premium cost, which makes the benefit taxable and results in you receiving less money. We’ll also assume the plan design covers 60 percent of your “base earnings.” Base earnings typically don’t include variable compensation like bonuses, over-time, commissions or other employer-provided perks—leaving your additional income uninsured.
Here’s an example:
Base earnings $75,000 annually, or $6,250 per month.
60 percent of base earnings is $45,000, or $3,750 per month.
Assuming a 10 percent effective tax rate for federal and 4 percent for the state means that the $45,000 annual disability benefit is reduced to approximately $38,700, or $3,225 per month. I think it’s safe to say few people are aware of the impact of taxes on their disability insurance payments. The effects on an individual’s or family’s finances could be devastating if you needed to access your benefits.
This impact is even more of an issue when you have significant variable income not covered under the definition of the group LTD contract. Business owners, sales people and employees who are eligible for bonuses and/or commissions may find the group plan even more inadequate since many group LTD contracts do not include that additional income in the calculation of benefits.
Another issue that may affect the more highly-compensated individuals is the group plan “LTD cap,”which is the maximum amount of benefit payable under the plan. Smaller employers usually have caps of $10,000 a month or less. It’s important to know that a 60 percent plan is by its design is going to limit the covered incomes as follows:
Cap Salary Covered
When employees rely solely on their group LTD coverage, the percentage of income replaced can be inadequate. A better strategy you may want to consider is to add individual supplemental disability insurance coverage because the combination of the two protects a larger percentage of your income by filling in the gaps left by your group LTD coverage.
In addition to understanding how your group LTD plan works (if you have one), it is important to also know about how income protection options available from other sources work. Two other common sources of income when you cannot work are Social Security Disability Insurance and worker’s compensation. These programs do not pay you benefits in all situations and the process to qualify for SSDI can be lengthy. While each is important and should not be ignored, the reality is neither program will most likely allow you to continue your current lifestyle if you need to tap into these programs.
The SSDI program provides disability benefits to those with significant impairments and uses the following criteria to determine if you are eligible for benefits.
The definition of disability under Social Security is different than other programs. Social Security pays only for total disability. No benefits are payable for partial disability or for short-term disability.
We consider you disabled under Social Security rules if:
- You cannot do work that you did before;
- We decide that you cannot adjust to other work because of your medical condition(s); and
- Your disability has lasted or is expected to last for at least one year or to result in death.
If you are denied SSDI benefits you may file an appeal. This process can take several months to several years before a determination is made.
If you qualify for SSDI benefits, it’s important to know that your payments start after five full months of total disability. This is far less comprehensive than found in most group LTD plans, which normally provide an elimination or waiting period that normally includes partial disability and includes an “own occupation” definition of disability, followed by an “any occupation” definition, based upon your background, training or prior income.
In addition, SSDI provides a bare-bones level of protection. For example, someone meeting the annual income maximum for withholdings ($128,400 for 2018) would qualify for a $2,886/month, or $34,632 annually, which is 27 percent of their pre-disability income. As your income rises above the withholding amount, that percentage continues to reduce.
And, one final note: 85 percent of your SSDI benefit is also subject to federal income tax withholdings.
Worker’s compensation is another social program employees often think they can rely upon. It’s difficult to generalize about WC because each state program is unique. The primary purpose of WC is to provide benefits to workers who are injured or become ill on the job. These benefits may include income payments, medical assistance and vocational rehabilitation support.
Here’s the bottom line: Most employees would be well served by taking time to understand their income protection options and develop a plan from there. For employees who have short- and long-term disability insurance through work, I recommend asking your HR department for additional information about how the program works. A good first step is to ask for and review the group LTD booklet. This is usually available on your employer’s intranet site. If supplemental disability insurance is available through your employer’s benefit plan, strongly considered adding this coverage. You may be able to also take your supplemental coverage with you if you move on to another employer. Group LTD plans seldom are portable, and even if they are, they usually only continue for 12 or 24 months.
Having your own individual long-term disability plan may be the best investment in maintaining your lifestyle if you become injured or ill.