Short and Long Term Disability Insurance

Disability insurance, both short- and long-term, is a valuable part of your overall financial plan.  It offers income protection for periods of serious illness or injury.  Many employers offer one or both of these benefits, often free or at very reasonable cost.  It is also possible to buy individual short and long term insurance – many companies offer these policies at competitive rates.

In this post, I give an overview of how these policies work and their interaction with other benefits and laws.  I specifically address short-term disability insurance for pregnancy and maternity leave, a common concern and use of the benefit.

Short Term Disability Insurance

What Is Short-Term Disability Insurance?

Short-term disability (STD) insurance is coverage that acts as income replacement while you are too ill or injured to work for an extended period of time.  Plans typically cover absences for three to six months, depending on the terms of the policy.

Filing A Claim

If you have short-term disability insurance through your employer, you might have to use any available sick leave before the STD kicks in.  You might also have the option of saving your sick leave and going straight to the disability pay.  The application and payment process will vary depending on how your employer has structured the benefit – whether you work with the insurance company, the Human Resources department, or some combination.

If you have an individual plan, you will probably be working directly with the claims department of the insurance company from which you’ve purchased the policy.

Regardless of how you have to file a claim, you must submit medical documentation that supports your claim that you cannot work.  The insurance company or your employer will often have the option of requesting a second medical opinion.

How Much Will STD Pay?

There is a lot of variation in the level of income replacement among short-term disability policies.  It can range from 60%-95% of your salary at the time of disability.  If you have a group benefit through your employer, you should be able to get this figure from your benefits staff.  If you purchase an individual short-term disability insurance policy, be very clear about how much coverage you are buying.

This brings up the issue of how much disability insurance will cost.  It’s hard to give a representative figure because there’s an incredible amount of variation depending on your location, profession, salary, age, and whether or not you have a group or individual policy.

The premiums for group plans should be clearly stated by your employer, are often based on your salary, and will be deducted from your paychecks.  For an individual plan, get multiple quotes since rates can vary a lot depending on the company, the level of the benefit, your profession, and what medical conditions are eligible under the policy.  Make sure you find out if the benefit is capped at a certain income level.

Some employers have what is called a self-insured STD plan, which means they pay any claims directly out of their own funds and don’t have an insurance policy.  In this situation, you will likely be paid through the normal payroll process.  Where an insurance policy is involved – whether individual or group – you will usually be paid by the insurance company.

Tax Treatment

Whether or not payments you receive under a short-term disability insurance policy are taxable income depends on how you paid the premiums, at least for federal taxes.

  • If you pay the premiums with before-tax dollars – or your employer pays the premiums – any benefits paid will be taxed.
  • If you pay the premiums with after-tax dollars, any benefits paid will not be taxed.

States and local governments can treat STD benefits differently than does the federal government.  For example, Pennsylvania does not tax any short-term disability benefits, and the city of Philadelphia exempts STD payments from the city’s wage tax.  Your employer or insurance company should have information about the taxability of your benefits.

Long Term Disability Insurance

 What Is Long Term Disability Insurance?

Like STD, long-term disability (LTD) insurance is coverage that provides income replacement in the event of serious illness or injury that prevents you from working.  LTD, however, is used when your recovery takes much longer or you are permanently disabled.  Benefits usually kick in within six to twelve months of the initial disability, depending on the terms of the policy.

Employment-Based Long-Term Disability Insurance

Many employers offer LTD and pay for the premiums.  In some situations, you can “buy up” the benefit, meaning the employer pays for a base level benefit, perhaps a 60% income replacement level, and the employee can pay for supplemental coverage that might add another seven to ten percentage points to the benefit.

Individual Policy

Like STD, you can also buy an individual policy on the open market from one of many different insurance companies.  Shop around.  You might be able to get discounts for buying multiple lines of insurance from the same company, so don’t hesitate to get a whole range of products quoted together, such as STD, LTD, life insurance, and auto and house insurance.

Benefit Levels and Filing Claims

By far the most common benefit levels for LTD insurance are 60% and 66% income replacement, and there’s often a cap on the income base that will be covered.  So high wage earners should examine the terms of their policy – group or individual – very carefully to make sure there’s no unpleasant surprises in the event of a claim.

When filing a long-term disability claim, you will, of course, have to provide medical documentation.  Don’t be surprised if it’s subject to more rigorous evaluation by the insurance company than for a short-term disability claim.  After all, the potential liability is much higher for the insurance company: if you’re 35 and found to be permanently disabled, they will have to pay out over 30 years of benefits.

Most plans will require you to also apply for Social Security Disability Insurance.  If approved, the LTD payments from the insurance company will almost definitely be offset by your Social Security benefit.

Laws Related To Disability Insurance

There are a number of laws at both the federal and state levels that affect disability insurance coverage.

State Laws

A number of U.S. states regulate disability insurance policies quite closely.  They set minimum standards and might control the premiums that insurance companies can charge.  A few, such as California and New Jersey, even have their own state short-term disability insurance programs.

These state disability programs are funded by employers.  Employers can choose to pay into the fund or can provide a private plan that at least matches the level of benefits offered by the state program.

Check with your state insurance board or your employer to find out what regulations affect disability insurance in your location.

Pregnancy and Maternity Leave

Under the Pregnancy Discrimination Act of 1978, pregnancy and maternity leave must be treated the same as any other disability for purposes of short-term disability benefits.  Bed rest, if medically indicated, is included.  Most states have guidelines that set how much disability you are entitled to after delivery.  Common time frames are

  • Vaginal delivery:  6 weeks
  • Caesarean delivery:  8 weeks

If you are eligible for Family and Medical Leave (FMLA), you will also have 12 weeks that will likely be administered concurrently with your disability.  Your employer can set policies about how much paid leave you can use in addition to the STD.

For example, the company might let you use sick leave during your FMLA period and then any accumulated vacation time for up to 6 months total.  Assuming you didn’t have any bed rest before delivery; had a vaginal delivery; and started with a leave balance of 35 days sick and 15 days vacation, your maternity leave might look like this:

  • Weeks 1 through 6:  Short-term disability payments; first 6 weeks of FMLA
  • Weeks 7 through 12:  Sick leave (30 days); remaining 6 weeks of FMLA
  • Weeks 13 through 15:  Vacation
  • Weeks 16 through your return to work:  Unpaid

If you are planning on getting pregnant, check with your benefits department to make sure you understand what types of leave are available to you.  There can be an enormous amount of variation by employer within the framework of the Pregnancy Discrimination Act, FMLA, and short-term disability insurance provisions.  Remember, in most states, employers are not required to have a short-term disability policy.

Conclusion

Disability insurance, particularly if you don’t have a very large emergency fund, can be an important part of your overall financial plan.  Whether you can get it through your employer or must buy it on the open market, think about how you would pay your living expenses should you fall seriously ill or get injured when making your decision about taking the coverage.

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