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Disability Insurance: Is Your Coverage Enough?

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If an unexpected illness or injury left you unable to work for an extended period — perhaps indefinitely — is your disability insurance enough to sustain your family’s lifestyle and cover your ongoing care?

While many companies offer employees access to short- and long-term disability insurance as part of their benefits package, it may not be enough to cover your and your family’s expenses in the event of an injury or illness. High-earning executives are especially vulnerable to a shortfall. Evaluating your current coverage to determine how much disability insurance you need to minimize the potential financial impact on your family is critical. That process starts with understanding the different types of policies available to you and what they cover.

Base/Core Disability Benefits

There are two distinct types of employer-provided plans for income protection: short-term and long-term coverage. These plans offer benefits based on a percentage of your regular earnings and may or may not include cash bonuses, commissions, and incentive-based income, depending on the policy. Typically, long-term policies are also subject to a maximum monthly benefit, which is set by the issuing company based on those who qualify for the employer plan.

Supplemental Benefits

Some employer-sponsored disability plans are designed to provide additional benefits for key executives. This type of executive plan may offer enhanced or supplemental benefits in the form of coverage for a larger percentage of earnings, a broader definition of earnings (e.g., salary and bonus) or a more liberal definition of disability. But even with supplemental benefits, the plan may still fall short for high-income earners, requiring additional coverage.

Right-Size Your Coverage with Individual Disability Income Protection

If your employer disability coverage is insufficient to sustain your family’s lifestyle if you were to become disabled, consider covering the gap with an individual disability policy.

Individual policies offer several key advantages: 

  • Tax-free monthly income. When you pay the premiums, benefits are received tax-free under current tax law.
  • Higher income replacement limits. This enables you to obtain close to 70% coverage of your full compensation (i.e., salary and incentive compensation).
  • Portability. When you own the policy, it can move with you as you pursue other career opportunities.
  • Extended coverage. With most group policies expiring when the insured reaches age 65, individual coverage is often available through ages 67 to 70.
  • Increased latitude. There may be some variance from carrier to carrier when it comes to defining what constitutes a “disability.” Individual policies can be more flexible in this regard and may also offer coverage for a partial disability.
  • Cost of living adjustments. This feature protects payments from the impact of inflation. In the event of a long-term disability, the cost of living benefit in an individual plan will increase the monthly payment based on the rate of inflation. This can help protect the benefit from the resulting erosion of value.
  • Catastrophic benefit. This can help pay for the care needed due to an extreme injury or illness. It can apply if you suffer a complete loss of one of your senses, such as your hearing or vision, but can also be defined as being unable to perform at least two of the six “activities of daily living” without assistance. These include bathing, dressing, eating, using the restroom, continence and transferring (for example moving oneself into a wheelchair) unassisted.
  • Broader definition of disability. Individual policies provide the insured with the “own occupation” definition of disability. If you are totally disabled and unable to perform the substantial and material duties of your regular occupation, the insurance company will pay the full benefits even if you return to work in another occupation.
  • Coverage for partial disability. Unlike group plans, individual disability policies can provide benefits even if you are partially disabled or have residual effects from your previous disability. (“Residual disability” refers to loss of income due to the loss of ability to perform some of the duties of your own occupation).

Case Study: How Supplemental Coverage Helps Close the Gap

Annie is a business development executive for a cyber security firm. Her base salary is $420,000, and she also receives an annual 33% cash bonus of $138,600. As part of a long-term incentive plan, she also receives an additional 33% of her salary in stock options. Her salary plus incentives brings her annual total income to $697,200.

This winter, Annie broke her femur in a skiing accident. Unfortunately, her injury required multiple surgeries that left her unable to return to her role’s demanding travel schedule for almost a year. Annie’s group and supplemental long-term disability insurance from her employer cover 60% of her salary for a year — providing a combined maximum monthly benefit of just $21,000, however, and leaving her with an income gap of more than $37,000 a month. The example below shows how Annie can narrow this shortfall with an individual policy:

  •  Employer Base LTD* = $420,000/year x 60% = $252,000/year ($21,000/month). Max benefit = $15,000/month ($180,000/year)
  • Employer Supplemental LTD Disability** = $252,000 - $180,000 = $72,000/year ($6,000/month)
  •  Individual Policy = 60% of Salary + Incentive Less Employer Benefit = $697,200/year x 60% - $252,000/year = $166,320/year ($13,860/month)
  • Total ER Base LTD + ER Supplemental LTD + Individual LTD = $34,860/month ($418,320 = 60% of $697,200/year)

*Employer Base LTD Coverage = 60% of Gross Salary up to $15,000/month through age 65

**Employer Supplemental LTD Coverage = Covers the difference between 60% of Salary and Base LTD Monthly Maximum through age 65

Source: Northern Trust Wealth Management

Additional Considerations When Collecting Under a Disability Policy

It helps to factor in the tax treatment of any payments when determining how much disability coverage you need. For instance, if your employer pays the premiums, any income paid under the policy is reportable to the IRS. The amount related to the coverage you pay for directly, however, is not taxed as income.

Also, with either employer-sponsored or individually owned policies, the contract may include a provision allowing for benefits to be reduced or offset by any Social Security Disability income received. This applies to disabled workers under the age of 65 and their families.

For guidance in determining the optimal level of coverage you require and selecting among policies and providers, consult an advisor.

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Disclosures

This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel.  All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.

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