Financial Planning 101

Don’t Pass on Long-Term Disability Insurance

When it comes to long-term disability many think, “It will never happen to me.” But according to the Social Security Administration, just over a quarter of today’s 20-year-olds will become disabled before reaching 67.

The Business Journal posed a series of questions to Ryan Glinn, a financial advisor with W3 Wealth Management LLC, to learn the details of long-term disability insurance and why nobody should pass on coverage.

What exactly does long-term disability insurance cover and why do I need it?

Long-term disability insurance provides a monetary benefit in the event the policyholder suffers an extended disability, typically beyond 90 days, due to an illness or accidental injury. Benefit amounts are based on a percentage of the policyholder’s annual income.

According to statistics from the Council for Disability Awareness, the average individual disability claim is more than 2 1/2 years, and the American Journal of Medicine cites a one-in-eight chance a working individual will be disabled for five years or more.

Unfortunately, disabilities happen, and when they do, they can rob families of their most important asset – not their house or car or 401(k), but their income.

Income drives our ability to make monthly mortgage payments, car payments, fund our 401(k) and pay for life insurance to protect our family. Disability insurance is designed to protect our income, which is why many Americans carry it as part of the risk management portion of their financial plans.

Is having group long-term disability insurance through work enough coverage?

It depends. First and foremost, it’s important to understand how your group long-term disability insurance (LTD) works.

Group long-term disability insurance contracts usually have a 90-day elimination period, meaning benefit payments won’t kick in until the 91st day of your disability.

Typically, group LTD policies cover anywhere from 50% to 66% of your base monthly income depending on your employer’s plan. It’s important to note that any income received from commissions or bonuses is often excluded.

If you pay for your policy, the benefit will be tax-free. However, if your employer pays, benefits will be fully taxable to you based on your ordinary income tax bracket. Most group long-term disability insurance benefits pay out 50% to 60% of monthly income depending on taxes.

This begs the financial planning question: Can my family and I survive if my income is cut roughly in half? And if so, for how long?

An issue that is often overlooked is the fact that a long-term disability usually requires substantial medical treatment, which adds to the expense column. Of all personal bankruptcies in the U.S., 60% are because of medical bankruptcy, according to Policygenius.

A long-term disability scenario can be modeled in many of the financial planning software available today. Over an extended time period, it is common, particularly for individuals 25 to 40 years old, that there are not enough liquid assets in place to adequately fill the income gap group long-term disability insurance doesn’t cover. This is where the need to purchase a supplemental, individual policy may arise.

How does an individual long-term disability policy compare to my group policy?

While group policies are purchased through salary deferral, individual policies are acquired in the open market, typically from a financial adviser or insurance agent.

They are commonly used to supplement group policies to reach the legal maximum benefit amount, usually 75% to 85% of income. To be issued an individual long-term disability policy, the applicant must be approved through medical underwriting. They must also prove income by submitting W-2 forms or pay stubs.

Pricing is based on age, gender, health and the nature of one’s occupation. An accountant is statistically less likely to become disabled than a construction crew manager and policy premiums reflect that.

On the other hand, group LTD is done on a “guaranteed issue” basis. No underwriting is required. While this may seem beneficial, group policies often have language in the fine print that excludes certain medical conditions and even some pre-existing conditions the individual may have been treated for prior to their employment. This is the insurance company’s way of controlling cost of claims due to adverse selection. It’s always important to read your group contract carefully.

Individual policyholders can access the “own occupation” definition of disability, which provides the most comprehensive coverage. Essentially, if a doctor deems the individual unable to do a specific job, benefits will be paid out.

This holds true even if that person would be deemed able to work in another profession or was receiving income from another job. An example of this would be a surgeon who could no longer perform surgeries, but became a teacher at the Northeast Ohio Medical University. Under a true own occupation definition, the surgeon would be entitled to her new teacher’s salary as well as her individual disability benefit.

Group LTD typically offers the “own occupation not working” definition, where any income received offsets disability benefits dollar for dollar.

Individual disability insurance is portable. If the policyholder changes jobs, the policy remains in force. Individual insurance also offers a variety of benefits through optional policy riders. Examples include inflation protection, residual benefits for partial disabilities and enhanced benefits due to a catastrophic disability. Another well-known rider is the Future Increase Benefit, or FIB. This allows individuals to attain more coverage in the future without having to prove medical insurability. This rider is particularly popular with medical residents and other professionals who expect significant pay increases over time. Group disability insurance usually offers flat benefits and no riders.

Why would I purchase an insurance policy when I can get on workers’ compensation or collect social security disability?

Workers’ compensation through the state of Ohio entitles you to 72% of your income for the first 12 weeks of a disability and 66.6% each week thereafter. Benefits are capped at 200 weeks, or 3.85 years, unless declared permanently disabled due to the inability to hold long-term employment or the loss of any two limbs or both eyes. However, workers’ compensation only pays out benefits if a sickness or injury occurs on the job.

Social Security Disability Insurance, or SSDI, has a five-month waiting period from the date you are declared disabled before benefits are received. SSDI is notoriously difficult to attain and is done through a rigorous application process. In order to be approved, the disability should be expected to last at least 12 months or result in death, according to Dalton Education.

The current approval rate for first-time applicants is 36%, while approval for reconsideration requests is a mere 13.8%, reports the Social Security Disability Resource Center. To add insult to injury, the average time it takes to process an appeal is nearly two years, according to the Minnesota-based MarketPlace. It usually requires hiring a disability attorney.

It is completely logical to think that one would receive group long-term disability insurance, SSDI and workers’ compensation benefits. However, this is where most group LTD contracts fall short. Almost all group LTD policies include a provision that allows a dollar-for-dollar offset of group benefits with SSDI and workers’ compensation.

Let’s say I’ve been declared medically disabled for 12 months and currently receive $3,000 of group LTD benefits monthly. I was not hurt at work, so workers’ compensation is irrelevant. However, SSDI ruled I was eligible for $2,000 monthly because of the severity of my injury.

I would not receive $5,000 monthly. Rather, I’d be entitled to $2,000 from SSDI and $1,000 from group LTD. Additionally, SSDI provided me a backdated lump sum check for $14,000 to account for the seven months I should have been receiving benefits after the five-month SSDI elimination period. Unfortunately, my group LTD insurance company would be entitled to that check.

An advantage of owning an individual LTD policy is that benefits do not normally offset with SSDI or workers’ compensation.

The opinions expressed in this article are those of author and should not be construed as specific investment advice.  All information is believed to be from reliable sources, however, no representation is made to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. Any tax advice is of a general nature. Further, you should seek specific tax advice from your tax professional before pursuing any idea contemplated herein.  Fee-based planning offered through W3 Wealth Advisors LLC, a state registered investment advisor. Third-party money management offered through Valmark Advisers Inc. a SEC registered investment advisor. Securities offered through Valmark Securities Inc. W3 Wealth Management LLC and W3 Wealth Advisors LLC are separate entities from Valmark Securities and Valmark Advisers. 

Published by The Business Journal, Youngstown, Ohio.