Luckily for you, your employer offers amazing benefits and you took advantage of them. Your good college friend recently spoke to you about how you can protect your family even more by getting an individual disability policy on top of the group disability from your employer. They noted the difference in “own occupation” versus “any occupation” and how individual policy is not dependent on your employer. All great advice. Yet, if not coordinated correctly, it can result in two policies that work against each other.
Many people don’t know that a disability is more likely than an early death. In fact, most Americans are better prepared for their death than if they were to become disabled, even though they are 3-5 times more likely to become disable before an early death. When it comes to the odds, it is nearly 2 to 1 for a 35-year-old male and almost 3 to 1 for a 35-year-old female for a disabling event during their working career.
To begin protecting yourself, look through the details about your group coverage offered by your employer. For people that take less conventional career paths, getting an individual policy in place while they are younger is a good way to avoid higher costs when purchased later in life. Or, you can consider using special benefit programs for contractors and small business owners.
Many employer group disability policies look to cover 40%-60% of one’s income with caps around $5,000 to $10,000 per month. Often, these group policies have defined a disability as “own occupation” for two years; If you are unable to perform your duties for your job, you will qualify for the disability. After two years, it often turns to “any occupation” meaning the disability has to be so severe that you are unable to perform any job to qualify for the coverage.
Due to the monthly caps, many high-income earners are extremely unprepared through the use of group coverage alone. For example, a physician who is making $250,000 a year working at a hospital or private practice has a disability group policy. The employer pays for the policy meaning it is taxable income to the physician. This policy is capped at $6,000 per month or 60% of one’s income, whichever is lower. If the physician has a disability event, it is going to cover $72,000 a year. 60% of $250,000 is $150,000 versus the $6,000 monthly cap is $72,000 and is the lower amount provided. This would put the physician in the 12% marginal tax bracket (if married filing jointly) and likely their effective tax rate will be around 7.39% (assuming standard deduction and no other sources of income). After taxes, the physician take home pay will be about $66,676 resulting in covering just around 34% of their current take-home pay. This example presumes no state income taxes and that you are no longer paying FICA taxes when you are on your claim.
We have listed the end results below.
Effective Tax Rate
28.30% (including FICA)
7.39% (not including FICA)
This is where an individual policy can close this gap. At the same time, if done incorrectly, you could be wasting your money on a policy that will not pay out. Many individuals fail to disclose that they have a group policy to their insurance agent and the agent fails to make sure that the individual policy does not have an “offset provision” excluding their current coverage. An “offset provision” are other sources of income that count towards the coverage. These are often social security, disability group policies, worker’s compensation, and benefits from state programs.
Based on this need, this physician purchased an additional $5,000 a month policy all under “own occupation” through to age 65. The physician thought it was going to add to their group coverage providing them a total of $11,000 a month between the two policies. Instead, the policy had an “offsetting provision” which caused the group policy to be counted towards the $5,000 a month offered under the individual policy. Only providing the $6,000 a month from the group policy. Sadly, this is a poorly planned disability insurance protection approach that commonly occurs.
Coordinating these policies with your overall plan to both grow and protect your wealth is vital. You want to make sure your team of experts has fully explored this, making sure your individual policies and group coverage pay nice together. If we can be of any help in reviewing your financial situation, schedule an appointment with us now!
James Hargrave, MBA, CFPⓇ, CLUⓇ
Director of Financial Planning