Employees underestimate the disability insurance coverage amount they need at open enrollment, benefits broker Allison De Paoli, founder of Altiqe, said. Some choose a disability benefit by its monthly premium, and others turn down the maximum, believing they do not need that much. Group long-term disability coverage usually pays at most 60 percent of salary up to a monthly cap, and the check is taxed as income when the employer paid the insurance premium, so the amount many employees elect covers less of their take-home pay than they assume.
The group election and an individual disability income insurance policy that adds to the group benefit are the two choices that set the size of the check. Employees who elect too little usually learn the difference at claim time, when the election can no longer be changed.
Group Disability Benefit of 60 Percent Shrinks Before the Deposit Arrives
De Paoli said her conversations with employees at enrollment come down to two subjects. Both shape the check an employee would receive.
“How the benefit is taxed and how much benefit they need. We always recommend the max they can purchase, which is usually 60% of their salary with a cap. We often hear ‘I don’t need that much’ and then we ask if they can live on 60% of their salary and they say no. We also explain the way taxes work if the employee pays for their own benefit or if it is employer paid, and then taxable.”
Allison De Paoli, Founder, Altiqe
The 60 percent figure is a ceiling, not a promise. Group plans usually let employees buy up to 60 percent of salary, and the monthly cap, the largest benefit the plan pays in any month regardless of salary, can hold the check below that line for higher earners.
Who paid the premium decides the tax treatment. A disability benefit is taxable income when the employer paid the premium and is not taxable when the employee paid it with after-tax dollars, according to the Internal Revenue Service. Premiums an employee pays pre-tax through a cafeteria plan, the payroll arrangement that takes deductions out before income tax, count as employer-paid, so those benefits are taxed too.
Consider a hypothetical employee earning $60,000 a year, or $5,000 a month before taxes, in a plan that pays 60 percent with a monthly cap above that amount. Caps vary by plan, and here the benefit works out to $3,000 a month before taxes. If the employer paid the premium, that $3,000 is taxed as ordinary income, so the deposit is smaller than $3,000.
Long-Term Disability Coverage Amount Picked by Monthly Premium Falls Short
De Paoli said employees choose a benefit one of two ways. She named the one she wants them to avoid.
“Either in the dollar amount of the benefit or by premium cost. I hate when people use premium cost. Not because the dollars aren’t important. You can buy too much insurance! However, if that is the primary reason, they often won’t take the full benefit and can be quite shocked if they use it and don’t receive what they thought.”
Allison De Paoli, Founder, Altiqe
A premium is the price of the coverage, not a measure of what the coverage pays. Employees who choose by price often take less than the full benefit, De Paoli said, and the shortfall appears when a claim is paid. That shortfall comes out of savings, or the bills it was meant to cover go unpaid.
Sizing the coverage amount against expenses rather than premium takes five steps an employee can finish before the enrollment deadline.
- Start with monthly take-home pay, the amount deposited after taxes and payroll deductions, rather than gross salary.
- Total the fixed bills that keep arriving during a disability, such as rent or mortgage, utilities, car and loan payments and other insurance premiums.
- Find the benefit percentage and the monthly cap in the plan’s benefits summary, multiply the percentage by monthly salary and hold the result to the cap.
- Reduce that figure for taxes if the employer pays the premium or the premium comes out pre-tax.
- Compare the after-tax benefit with the fixed bills and with take-home pay, and treat the difference as the amount savings or a second policy would have to cover.
Electing the full group maximum where it is offered, as De Paoli recommends, moves the after-tax benefit as close to take-home pay as the group plan allows. Step five then shows how much of the difference is left.
Waived Disability Insurance Coverage Comes Back With Conditions Attached
Employees who decline group disability coverage and return after a life event are often ineligible to enroll, or they face a pre-existing condition clause, De Paoli said. That clause, a provision that limits or excludes benefits for a condition treated shortly before coverage began, varies from plan to plan. She said claimants are also often surprised by the pre-existing condition question during a claim and by how long a claim takes.
An individually owned disability policy approaches the same problem from the other side. It is medically underwritten, meaning the insurance company reviews the applicant’s health history before it issues coverage. Bought while an employee is healthy, it is in place before a later health change can stand in the way of the application.
The disability insurance coverage amount an employee elects at open enrollment is usually locked in until the next open enrollment, and the check it produces replaces only part of the salary behind it. Employees who size that amount against take-home pay and fixed bills see the difference while they can still change it.
