Long-term Disability (LTD) Insurance

Long-term disability insurance replaces part of your income if you cannot do your job or a similar job after being disabled more than 6 months. (Short-term disability covers the preceding period.) SSDI provides benefits only if you are unable to work, whereas Long-Term Disability Insurance (LTD) pays if you are unable to perform your previous job for your employer.

The premium rate for long-term disability insurance varies based on several factors including the policyholder’s age, occupation, salary, the length of the waiting period before benefits begin, and the duration of benefits. Typically, premiums for long-term disability insurance range from 1% to 3% of your annual income. Get quotes from multiple insurers and compare their offerings to find the best rate and coverage for your needs. Group LTD bought through an employer is far cheaper than an individual policy, because it is capped, cancellable, and typically narrower in its definition of disability. Most employer plans are confidential, but public-sector employers publish theirs, making them a transparent benchmark for real-world pricing. The Massachusetts Group Insurance Commission — the benefits agency for Commonwealth employees — publishes its full rate schedule annually (Table 18.6).

The plan those rates buy: 55% of gross monthly salary, capped at $10,000 per month, after a 90-day elimination period, payable to 65, with a 36-month limit on behavioral-health disabilities and a partial-disability benefit — and it requires evidence of insurability, so it is not guaranteed issue. Read three things off the table. First, the shape: premium rises nearly ninefold from age 27 to age 57, because that is what morbidity pricing looks like. Second, the peak and decline — the rate falls after 59 not because risk falls but because the remaining benefit period to 65 is shrinking, which is also why buying late buys less than the premium suggests. Third, the absolute level: a 45-year-old earning $12,000 a month pays $120\times \$0.36=\$43$ a month for $6,600 of monthly coverage. That is extraordinarily cheap, and it is cheap because of the $10,000 cap and the contract terms — exactly the limitations section “The Contract Terms That Actually Matter at High Incomes” says an individual policy has to fix.

California publishes an equivalent schedule for state employees through CalHR, with separate factors for 55% and 65% coverage tiers, and most state and university systems do the same. If you want to calibrate what your own employer is charging, those are the comparables. Individual own-occupation coverage costs roughly an order of magnitude more than these rates and buys a materially different contract.

You need to decide whether to pay the premiums for long-term disability insurance. If you choose to pay these premiums, any disability payments you receive will be tax-free. If your employer pays the premiums instead, the disability payments you receive will be taxable. Although the likelihood of experiencing a long-term disability is low, the associated expenses can be substantial, especially for medical attendants.

Should you pay for your long-term disability insurance premiums using after-tax dollars so that one’s LTD benefit will not be taxed?

Work it with numbers. Take a household with a $100K salary plus $12K of RSUs and no bonus, a spouse earning $105K, and an estimated SSDI benefit of $2K per month. The mechanics of a claim:

1.

Gross benefit. Group LTD replaces 65% of base salary: $0.65\times \$100,000=\$65,000$ per year. RSUs are outside covered earnings, so the $12K vanishes — the first hole, and the one section “The Contract Terms That Actually Matter at High Incomes” says to close with an individual policy.

2.

SSDI offset. Once SSDI is approved (month 6, so effectively from year 2), the group policy reduces its payment dollar-for-dollar by the $24,000 annual SSDI benefit. The household still receives $65,000 in total — $41,000 from the carrier, $24,000 from SSA — but the tax character of the mix changes, which is the whole point of the exercise.

3.

Tax character. If the employer paid the premium, the entire $65,000 is ordinary income under IRC §105. If you paid it with after-tax dollars, the $41,000 carrier portion is excluded under IRC §104(a)(3), and only the SSDI portion is taxed — and only partially, per Table 18.5.

4.

Marginal rate. The spouse’s $105K keeps the household in the 22% federal bracket with California on top, so the benefit dollars are taxed at roughly 30% combined. Excluding $41,000 from tax is worth about $12K a year gross of the SSDI interaction; netting the partial SSDI inclusion and bracket effects gives the $6.6K first-year figure below, rising as SSDI phases in.

The premium costs $315 a year whether or not you claim. Table 18.7 runs the comparison across durations:

For single individuals who cannot rely on a spouse’s income, the fraction of after-tax income quickly drops to 60% as the duration of disability increases. The advantage of paying LTD premiums is slightly lower for single individuals compared to married ones, due to a larger taxable portion of SSDI payments, which is known as the marriage penalty in SSDI taxability.

The decision to pay LTD premiums largely depends on your risk preference. For instance, if you anticipate a disability lasting one year, the benefit-to-cost ratio is roughly 21 ($6.6K against a $315 premium), so paying the premium is advantageous if you believe there is at least a 1-in-21 chance of becoming disabled that year. However, given the low probability of becoming disabled, paying the premium may not seem beneficial. Nonetheless, disability insurance is what covers long-term, catastrophic events. If you lack other means of financial support, it might be wise to pay the premium to secure mostly tax-free long-term benefits. If instead you have other financial resources, such as a spouse’s income or external investments, and do not expect significant increases in expenses due to disability, paying the LTD premiums may not be necessary.

(It is fair to compare one year’s premium payments vs. multiple years of receiving disability benefits. Suppose one has paid premiums for a few years without becoming disabled. This is a sunk cost. During the enrollment period, one has to decide whether to pay premiums for the following year. If one does not become disabled during the year, one pays the full cost. If one becomes disabled, one might pay premiums for part of the year, but then one receives the benefits for as long as one is disabled, which might be multiple years.)