Long-term disability insurance pays limited income and medical support 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. It’s important to get quotes from multiple insurers and carefully compare their offerings to find the best rate and coverage that suits your needs. Example, for 2024, the premium rate is $0.315 per $100 of salary when purchase through employer. To calculate your premium, multiply your salary by this rate. Note that the maximum monthly payment cap is $20,000.
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. Conversely, if your employer pays the premiums, 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?
For example, suppose you have a $100K salary, receive $12K in RSUs but no bonus, your spouse’s income is $105K, and your estimated Social Security Disability Insurance monthly benefit is $2K.
For example, if you become disabled for one year, and your after-tax income will decrease by $26K compared to if you were not disabled, as disability insurance typically pays less than your full salary. The cost of paying LTD premiums is $315 annually if you do not become disabled. However, if you do become disabled, having paid these premiums results in an increase of $6.6K in your after-tax pay. Over a span of 10 years of disability, your income would drop by either 21% or 17%, depending on whether you pay LTD premiums. The overall benefit of paying these premiums over time amounts to approximately $78K. One gets a table like this:
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 and the benefit-to-cost ratio is 26, paying the premium is advantageous if you believe there is at least a 1 in 26 chance of becoming disabled. However, given the low probability of becoming disabled, paying the premium may not seem beneficial. Nonetheless, disability insurance is crucial for covering 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. Conversely, if 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.)