Help a Reader: Disability Insurance

Here's a question I recently received from a reader:

My employer offers long term disability insurance that will reimburse 60% of income if the disability lasts longer than 90 days. But it can be paid either by me or them. If I pay for it, the premium is paid with post-tax dollars and I get the advantage of having a tax free benefit in the event I become disabled. If my employer pays for it, the annual benefit gets taxed and therefore reduced. So it appears more advantageous if I pay for it, but am I missing something? Is there a catch? Shelling out a few extra bucks a month (post-tax) initially doesn't seem like a big deal, but keep in mind I live in New York (high living costs) and I'm going to be making less than $50K, base salary. Every dollar counts. Part of me also thinks that I'm still young and healthy so is it even worth shelling out for insurance I may never use? However I find this last one a less convincing argument...you never know what could happen. Thoughts?

My two cents is that if you have an income that you (and maybe others) rely on to live, you need to protect it. That's why you need disability insurance.

As for paying yourself or having the employer do it, anyone have any insights into which option is better?

Comments

[The Finance Buff]

There's no catch. Pay the tax on the premium now effectively increases your coverage. You are in a better position to pay now than when you are disabled.

[Ryan]

Another option is to self-insure. Set aside the money you would have put into the disability insurance into an interest bearing account, and before you know it, you'll have 3-6 months worth of living expenses in it. The huge benefit to this is that if you never get disabled, you still have the money. Another thing to consider is that the percentage of people below 45 that become disabled for longer than 90 days is very very low (like 1-2%).

[Beachgirl]

To go off of Ryan's post...I only pay $17 a month for long-term disability. Figuring at even 4% interest rate, over 10 years, and after 25% federal tax and 6% state tax, I'd have only saved $2,410.55. That's not even 1 month of my gross monthly salary, nor 60% of my net monthly income (which are roughly the same after all the deductions). If you're paying hundreds, then that might be a smart way to go. But if it's cheap, it's probably worth it to do it through your employer. And you're emergency fund is there as a back up in either case.

[Beachgirl]

I meant that after deductions, my gross monthly salary is roughly equal to 60% of my net monthly salary...just to clarify.

[Asithi]

You should let your employer pay for it. This is free money on the table. Even though the income will be taxed when you need it, you didn't have to pay for it. Besides your benefit at 60% of your income should put you in a lower tax bracket then. If you save some of your money in an emergency fund, you can cover the 40% on your own.

[Ken]

I think it would be better to pay for it so that you get it tax free. Pay $17 now and avoid $500-1k in taxes per month later when you need it.

I'm sure getting it through your employer is cheaper than getting it on your own.

Lets do an example. Say $60k per year salary. So $5k per month.

Scenario 1.
Company pay $20 per month.
On disability you get $3k (60% of $5k), then you need to pay taxes.
For simplicity, assume 25% bracket. You end up with $2250 a month.

Scenario 2.
You pay $20 per month, but need to earn $27 to take home $20.
Cost is $7 per month more for you.
On disability you get $3k tax free.

Now the question is how many months will you be on disability and how long would it take you to make up the $750 difference per month for however long you end up being on it, if you were to put away $27 per month.

And thats why this is insurance cause you never know.

Maybe the best bet would be, get your employer stuff for free. Then use the $27 per month to buy your own. But likely $27 per month wont get you much coverage. :(

[Sarah]

Although you're likely to be in a lower tax bracket if you're disabled, your expenses are also likely to go up significantly. Assuming reasonable premiums, pay them yourself.

[Seth]

You absolutely need to sign up for this, self-insuring is just plain reckless. I do not wish to start a flame war but I would like to see some citation for the 1-2% figure that The Finance Buff has stated since I have never seen a number that low.

There are a couple of additional questions you will want to ask:

1. Are both coverages for own occupation or any occupation? If you can get any occupation, you will potentially be better off than own occupation.

2. If you enroll in the employer option now (to save money), will you be able change your enrollment later (to get better coverage) without being subject to evidence of insurability?

All things being equality and without knowing the weekly or monthly cost, I would be inclined to get the company paid and then to price out some supplement LTD coverage though an agent. However under no circumstances should you opt out of this coverage.

[The Finance Buff]

Seth - You read the by line wrong. I didn't state the 1-2% number. It was in Ryan's comment, which appears after mine.

[Seth]

My apologies. The formatting confused me.

[Ryan]

Seth,

The 1-2% figure was a back of the envelope calculation based on different statistics that I googled on the web. I tried to find a good number, but each insurer said somthing different, and mostly only talked about the aged. Since the employer is paying the premiums for the taxable reimburesment, I hardly think it would be reckless to self-insure, although $17/month is very cheap as well.

[life insurance brokers Toronto]

You shouldn`t even think about not signing up for this insurance. I work for one of life insurance brokers Toronto and we always advice our clients to get a disability insurance. You can never know what will happen in the future. Many people underestimate this type of insurance until something bad happens (not that I say that it is your case). It is more advantageous to be insured even if you are not disabled, than to not be insured and become disabled.