Reprinted from the
Wall Street Journal
WEDNESDAY, FEBRUARY 5, 2003
Ruling Shows Benefits of Paying For Your Own Disability Policies
By Jane J. Kim
NEW YORK - Buying disability insurance may not be high on your priority list right now; especially if you already are covered by your employer or can't afford to pay the out-of-pocket premiums.
But a recent tax-court ruling shows that the benefits of paying for your own policies can provide you with a more comfortable cash cushion should you become disabled.
Many people typically don't think about buying disability insurance because most are covered through their jobs. However, such policies typically cap out at 60% of one's base salary, excluding any commissions or bonuses. Since the policy premiums are paid by the employer, benefits are taxed and often limited to a maximum of $5,000 to $10,000 a month. That means that on an after-tax basis, the benefits can drop to as little as 4O%, or less, of your base salary.
Earlier this month, a federal court ruled that more than $83,000 of an airline pilot's disability benefits were taxable because the premiums had been paid by the employer. The pilot, Thomas Tuka, had argued that he had paid the premiums because his union had accepted wage concessions in return for the disability coverage. However, the Internal Revenue Service had argued that because the wage concession amounts were never included in Mr. Tuka's gross income, he owed tax on the full benefits he received.
Experts say the ruling validates the idea that people should buy disability policies with after-tax dollars. If you can afford to buy a disability policy on your own that supplements or replaces your employer plans, then you potentially could save taxes on a much-larger amount, said Bob Scharin, editor of Warren, Gorham & Lamont/RIA's Practical Tax Strategies, a monthly journal written for tax professionals. The income taxes saved on benefits paid out will outweigh the premiums paid, he said.
Still, such premiums can be expensive, typically ranging from 2% to 37% of annual income. If that is too much, consider supplementing your employer-provided policies with one that replaces the amount that is lost to taxes, suggested Ric Edelman, a financial planner in Fairfax, Va. The cost of that policy typically should be only several hundred dollars.
Roughly 30% of working Americans have some form of disability insurance, according to Milliman USA of Seattle. The actuarial-consulting firm estimated that 20%, to 25%, of employees will become disabled for 90 days before age 65.
Finding the right policy can be difficult, since prices vary widely depending on your age, gender, occupation and health. If you're in the market for a policy, here are a few guidelines to keep in mind.
First, look for a policy that is non cancelable. It is the most expensive, but you will be able to lock in your rates and benefits. The next best alternative is a guaranteed-renewable policy. Your insurer can't drop you, but they can raise premiums for specific reasons as long as it is for a whole class of policyholders, such as all of those in one state. A conditionally-renewable policy is the most restrictive: The insurer can put any condition on your policy or raise rates at any time.
A policy with a broad definition of disability is also important. The most liberal policy is one called an "own-occupation" disability policy where the insurer will pay you benefits regardless of whatever occupation you take on if you can't perform the duties of your current job. Conversely, "any-occupation" disability policies require that you be unable to perform any work in order to get benefits.
If you are young, consider adding riders that will protect your benefits in future years, such as inflation riders. Future purchase options will allow you to buy more coverage as your salary increases. "Ideally, you'll have a policy that will provide benefits to age 65, where the benefits increase with inflation annually and where the benefits provide partial benefits for a partial disability," Mr. Edelman said.
Don't forget that if you change jobs, you will lose any disability coverage that you currently have through your employer. In this case, a long-term disability-replacement rider will convert your group policies into an individual policy without having to go through medical examinations, said Steve Crawford, a managing director at Guardian Disability Brokerage in Rockville,MD.
The price of your policy will be affected by the waiting, or elimination, period, from the start of your disability before the insurer starts paying your benefits. In general, the longer the elimination period is, the cheaper your premium.
And the longer your benefit period, the more expensive the policy will be. You can buy policies that offer disability payments anywhere from two years, five years, or up to age 65, when Social Security payments kick in. Certain policies even offer lifetime payments.
Finally, make sure you are comfortable with the financial strength of the insurer. Will they still be around and selling disability insurance when you need it? You can check out the insurer's ratings at Fimilac SA's Fitch Ratings, Moody's Corp.'s Moody's Investors Service Inc., A.M. Best Co. and Standard & Poor's Corp., a unit of McGraw-Hill Cos.
Keep in mind that if your employer pays for your disability premiums, then your taxable income will increase when you start taking disability benefits. As a result, you could find yourself facing higher hurdles to take certain deductions and miscellaneous itemized deductions, Mr. Scharin said. For example, medical expenses are deductible to the extent they exceed 7.51, of your adjusted gross income. When your taxable income rises, you are effectively making it more difficult to claim a medical deduction.
If you're counting on Social Security or workers' compensation to cover you in an illness, keep in mind that such policies are more restrictive. Social Security, for example, covers you only if you are unable to work at any job. Moreover. in order to be eligible for disability payments, your disability has to have lasted at least a year. Workers' compensation covers only job-related disabilities.