As an attorney, dedicated to representing disabled professionals with individual disability insurance (IDI) and long-term disability (LTD) insurance matters, I am often in the unenviable position of informing clients of the deficiencies in their coverage. Such was the case during a recent consultation with a civil litigation attorney who was forced to cease practicing due to a neurological disorder affecting his executive and cognitive function.
This attorney was part of a large litigation firm that provides its attorneys with an employer sponsored LTD plan as part of its benefits package. While my client had been approached by financial advisers over the years, seeking to sell him IDI products with true “own-occupation” coverage and a set monthly benefit, he declined to pursue such coverage and placed his financial security in his firm’s sponsored LTD plan.
Why Is Disability Insurance Important?
Statistics show that 25 percent of attorneys will cease practicing prematurely due to a disabling medical condition, see U.S. Social Security Administration, “The Facts about Social Security’s Disability Program.” SSA Publication No. 05-10570, January 2015. This, coupled with the fact that approximately a third of attorneys suffer from a mental health or substance use disorder, highlights the challenges attorneys face during the course of their careers.
The financial consequences of becoming disabled can be devastating if attorneys lack the proper financial planning. Specifically, studies indicate that 38 percent of disabled attorneys will struggle to pay their normal living expenses within three-months of losing their regular income. These studies also indicated that approximately 65 percent of disabled attorneys will be unable to pay their normal living expenses within one year of becoming disabled, see “Council for Disability Awareness, Disability Divide Consumer Disability Awareness Study,” 2010.
To avoid significant financial hardship, it is recommended that attorneys obtain disability insurance that provides a net benefit equal 60 percent to 70 percent of the attorney’s gross earnings. This general rule accounts for the applicability of tax consequences. However, as will be outlined below, there are a number of factors that can affect an attorney’s perceived disability coverage.
Three Issues That Affect Perceived LTD Benefits
- How is the monthly LTD benefit calculated:
Unlike IDI products, which contain a set numerical monthly benefit, LTD plans traditionally utilize a formula to determine the attorney’s monthly benefit. The LTD benefit is typically based on a percentage of the attorney’s “covered monthly earnings.” Generally, the LTD plan will state the attorney’s monthly benefit is the lesser of 60 percent of their “covered monthly earnings” or the maximum disability benefit (the number agreed upon when the employer negotiated the coverage and specified in the LTD plan.)
For example, an IDI policy might contain a set “maximum monthly benefit of $10,000.” Whereas a LTD plan might define the monthly benefit as: “The lesser of 60 percent of members covered earnings or the maximum monthly benefit of $10,000.” As will be outlined below, failing to understand the definition of covered monthly earnings can significantly impact an attorney’s perceived coverage.
To properly understand one’s coverage, attorneys should review the definition of their covered earnings. As outlined below, most LTD plans only apply your base monthly salary, excluding compensation such as bonus.
- The effect of other income benefits
Camouflaged within most LTD plans is a provision regarding other income benefits. This provision entitles the LTD plan administrator to reduce an attorney’s monthly benefit, dollar for dollar, if they are receiving income from any of the listed sources.
While the LTD plan will provide a detailed list, the most common other income benefits that could affect an attorney’s LTD benefit are: state disability benefits, Social Security benefits, workers’ compensation, salary continuation, voluntary retirement payments attributed to an employer funded plan, and benefits received from other group disability plans. In practice, the most common other income benefit that affects client’s LTD benefits is Social Security disability.
To assess your exposure to reductions based on other income benefits, you should thoroughly review the definition section of your LTD plan. If your LTD plan does contain a list of other income benefits, understand your LTD plan administrator will seek to apply a dollar for dollar reduction to your monthly benefit.
- Tax consequences
Similarly, unlike most IDI products, which are paid for with after-tax-dollars and provide a tax-free benefit, most LTD plans are paid for with pre-tax-dollars. This results in the disability benefit being subject to both federal and state income tax liability. As such, if an attorney is relying on an LTD plan that was paid for with pre-tax-dollars, and depending on where they live, the LTD benefit could be subject to federal, state, and city/local income tax obligations. These tax consequences can significantly reduce an attorney’s perceived coverage, jeopardizing their financial security.
To assess your tax liability, simply review how your premiums are paid with your employer or a certified public accountant.
- The consultation
When my client first sat down to discuss his LTD coverage, he was adamant that he had a $10,000 a month benefit, that provided him with an annual benefit of $120,000. We discussed his earnings, and he advised that his annual gross income was $250,000. His base salary was set at $150,000 and he had an annual production-based bonus of $100,000. The LTD plan defined his monthly benefit as “the lesser of 60 percent of your covered monthly earnings or the maximum disability benefit of $10,000.”
My client stated that he was entitled to the maximum monthly benefit of $10,000, and that simple math confirmed the same:
- $250,000 divided by 12 months provides an average monthly income of $20,833,
- 60 percent of $20,833 provides a monthly benefit of $12,500,
- $12,500 is greater than the maximum monthly benefit of $10,000,
- As such, he was entitled to the maximum monthly benefit of $10,000.
However, by not accounting for the definition of covered monthly earnings, the applicability of other income benefits and tax consequences, he significantly miscalculated his monthly benefit, placing his financial security at risk.
- Covered monthly earnings
The definition of his covered monthly earnings was not located on the specification page. Rather, it was buried in the LTD plan, and contained language limiting his covered monthly earnings to his base salary and specifically excluding commissions and bonuses compensation.
Based on this definition, the LTD plan only recognized his $150,000 base salary, excluding his $100,000 production-based bonus from his benefit calculation. By excluding the $100,000 of bonus income, his monthly LTD benefit was reduced from the anticipated $10,000 a month maximum benefit, to $7,500 a month. By not fully understanding the definition of his covered monthly earnings, the client overestimated his monthly LTD benefit by 25 percent. This reduced his monthly benefit by $2,500 a month/$30,000 a year.
To confirm your monthly benefit, review the definitions contained within your LTD plan. If you still have questions, discuss the same with human resources or someone with knowledge and experience dealing with these products.
- Other income benefit offsets
Based on this client’s medical condition, he will be eligible for Social Security disability. This will provide him with a monthly benefit of $2,500/$30,000 a year. Under his LTD plan, his $7,500 a month/$90,000 a year benefit discussed above will be reduced to $5,000 a month/$60,000 a year. By not fully understanding the definition of his other income benefits and covered monthly earnings, the client overestimated his monthly LTD benefit by 50 percent.
To understand the effect of other income benefits on your LTD plan, review the itemized list and assess your potential eligibility for each noted benefit. Add these numbers together and reduce them from your noted monthly benefit. This will provide you with a general estimate of potential reductions in your LTD benefit.
- Tax liability
This client also did not account for the tax liability on his LTD benefit. The client confirmed 100 percent of the premiums for his LTD plan were paid for by his employer with pre-tax-dollars. Based on where this client lived, 100 percent his benefit was subject to federal, state and city income tax liability.
Accordingly, his $5,000 a month/$60,000 a year benefit was subject to a combined tax liability of approximate 35 percent. His tax liability reduced his benefit from $5,000 a month/$60,000 a year to $3,250 a month/$39,000 a year.
To assess your tax liability, simply review how your premiums are paid with your employer and certified public accountant. If the premiums are paid for with pre-tax dollars, then the benefit is most likely subject to tax liability.
The Illusion of Coverage
By combining the above, the importance of thoroughly understanding the provisions within an attorney’s employer sponsored LTD plan should become apparent. When this client entered my office, he was under the assumption that his LTD benefit would provide $10,000 a month/$120,000 a year. Words cannot explain his response to learning that he overestimated his coverage by 61 percent, leaving him with a LTD benefit of $3,250 a month/$39,000 a year to support his family.
With this in mind, review your LTD plan and confirm your coverage. Consult with a qualified professional to ensure you have the appropriate level of coverage to support your family’s needs should you become disabled. Your financial security may one day depend on it.
Ethan F. Abramowitz, is a disability insurance attorney at Seltzer & Associates in Philadelphia. He focuses his practice on the representation of disabled physicians, dentists, lawyers and business executives. He is licensed in Florida, Pennsylvania, California. Contact him at Ethan@Seltzerlegal.com.