When you add up your income throughout your career, it will most likely be your single biggest asset. Without it, your ability to support yourself and your loved ones, as well as the future you envision, may be at risk. Even if you have group long term disability insurance through your employer, it may not be enough. Lets take a closer look.
A typical group long-term disability plan covers 60% of your “base” income (not commissions or bonuses) after a 90-day waiting period. Once on claim, your benefits typically can go out to age 65 or 67.
This sounds great, right? Well, partially. If you work for an employer that provides this benefit, it is a great start in protecting your paycheck. But it only partially addresses the issue. If your employer pays the premium for your disability insurance, the benefits are taxable to you.
If your employer pays the premium for your disability insurance, the benefits are taxable to you.
Group long-term disability plans are normally a benefit paid by the employer, which then makes the disability benefit taxable to you when on claim. We already mentioned that usually 60% of your “base” income is covered in this type of plan. Let’s take a look at an example with real numbers. This example shows an individual earning gross income of $96,000 annually ($8,000/mo) with a total tax burden of 28%.
As you can see, the assumed total income tax burden of 28% will bring down your after-tax, take-home pay to 72% ($5,760/mo). If you go on disability claim, you would have 60% coverage, but remember – that benefit is taxable. Once income taxes are deducted from the 60% disability coverage, take-home pay falls to 43% ($3,440/mo).
Back to where we started – Can you live on 43% of your income? And it could actually be less than this. If any of your compensation includes commissions or bonuses, your after-tax, take-home pay while on disability claim will be even less than 43% using the example above. Your true income replacement could be as little as 30-40% of gross income.
If any of your compensation includes commissions or bonuses…..your true income replacement can be as little as 30-40% of gross income.
No matter your income level and assumed tax burden, this exercise shows a similar result.
How can you protect more of your income in the event of a long-term disability? Obtaining an individual disability insurance policy in addition to your group disability coverage is usually the best option. Here’s why:
- Your individual disability policy will cover commissions and bonus income.
- Your individual disability policy will provide an income tax-free benefit.
- Your individual disability policy will stay with you no matter where you are employed in the future. This is especially important if you later work for an employer that does not offer a group long-term disability program.
- Your individual disability policy may have contractual provisions and benefits that are superior to your group disability program.
Supplementing your group coverage with an individual disability insurance policy will provide you with a much higher after-tax, take-home pay (up to 80% income replacement) in the event of a disability.
Disability insurance is one of the easiest types of insurance to dismiss, especially if you feel you are “already covered” by your employer’s group disability plan. If an illness or injury prevents you from working (much more likely than dying prematurely), obtaining the appropriate amount of disability income protection insurance can protect your lifestyle and keep you on track with your financial goals.