Understanding the Relationship Between Disability Income Insurance and Social Security Disability Benefits
There is some confusion about the relationship between individual DI insurance and SSDI. This column will explore this relationship. Three questions will be answered: (1) What does SSDI cover and how does SSDI work; (2) How does SSDI compare to individual DI insurance; and (3) How do individuals purchase an individually owned DI insurance policy?
How SSDI Works and What SSDI Covers
- Premium. The annual amount the employee (and/or the employer) pays for the policy.
- Waiting period – also called an elimination period. The amount of time after the disability insurance policyholder is disabled until he or she can start receiving benefits.
- Definition of total disability. Every disability income insurance policy has a specific definition of what it takes to qualify for total disability benefits. There are two types of definitions:
- An own-occupation definition means that the policyholder qualifies for benefits if a disability prevents the policyowner from working in his or her specialty or field.
- Any occupation means that the policyholder qualifies for disability benefits if he or she cannot perform any type of work in which he or she is somewhat qualified.
- Benefit. The amount of money the policyholder gets each month while he or she is too sick or injured to work, and
- Benefit period. The length of time the policyholder receives benefit.
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SSDI is a federal government-sponsored disability insurance program that is part of an individual’s Social Security benefits. These Social Security benefits include retirement benefits and disability benefits and are paid for by Social Society beneficiaries via the FICA payroll tax. The FICA payroll tax is 6.2 percent, paid by both the employee (deducted from their wages) and matched by the employer for a total of 12.4 percent. Of the 6.2 percent, 5.4 percent is contributed to the Social Security's retirement trust fund and the other 0.8 percent is contributed to the Social Security disability trust fund.
However, an individual’s paying the Social Security FICA tax does not automatically qualify the individual for disability and retirement benefits. The individual also needs to have earned a minimum number of Social Security work credits. In order to qualify for Social Security disability benefits, an individual needs to be “fully insured” ( having earned a minimum 40 credits of Social Security, 20 of which were earned in the last 10 years before the individual became disabled) or if not “fully insured”, then the individual must be “currently insured” (having earned at least 6 credits of Social Security during the 13 calendar year quarters ending in the calendar year quarter the individual becomes disabled).
There is a 5-month waiting/elimination period before an individual who is eligible for Social Security disability benefits will start receiving disability benefits. This waiting/elimination is comparable to many individual long-term disability (LTD) plans. This relatively long waiting/elimination period may not provide protection for shorter-term disabilities that keep an individual out of work for a few weeks or months. For federal employees, building up a sufficient amount of sick leave hours may be a possible solution in case of a short-term (less than six months) disability.
The Social Security Administration (SSA) has a strict any-occupation definition of disability that covers a specific and limited set of severe medical conditions listed in the SSA’s “Blue Book.” That means that SSDI only pays benefits for long-lasting or permanent medical issues that make an individual incapable of performing any work of any kind.
In addition, the process of getting SSDI benefits is significantly stringent. The initial application requires extensive documentation and can take months to complete. About 2/3 of SSDI claims are rejected by the Social Security Administration. While an initial rejected application can be appealed, the process can stretch out for years. If an SSDI claim is accepted, the individual qualifying for SSDI will start receiving a monthly benefit once the 5-month elimination period is completed. The average monthly SSDI benefit is slightly over $1,000. Federal employees are encouraged to check their online Social Security accounts (www.ssa.gov/myaccount) to find out what their monthly SSDI benefit would be in current dollars if they became disabled and qualified for SSDI monthly benefits. The benefit period for SSDI monthly benefit lasts until age 65, unless a disability resolves itself earlier at which time the SSDI recipient qualifies for Social Security retirement benefits.
An important question employees should ask themselves: Does SSDI provide enough income protection? While the benefit period lasting until age 65 is rather generous, there are two problems associated with SSDI. First, the strict “any-occupation” definition of disability. An individual will not qualify for benefits unless he or she suffers a catastrophic disability. The “any-occupation” definition can be a problem for professionals and trades people who have spent years getting educational degrees and certifications that allow them to earn high salaries. The second problem associated with SSDI is that the average monthly SSDI benefit of slightly over $1,000 may not be adequate enough for most individuals to live on. That is why insurance professionals recommend that individuals should not rely on SSDI alone for long-term disability income protection and look into long-term disability income insurance.
Individual Long-Term Disability Income Insurance
Long-term disability income insurance, also called LTD insurance, is for the same kinds of long-lasting disabilities covered by SSDI. However, LTD is usually easier to qualify for, and the benefit amount could be much more generous, depending on the policy and circumstances. An individual must apply for individual LTD insurance from an insurance company offering LTD insurance. The individual’s application goes through underwriting including the applicant’s medical records being reviewed. The individual can in fact be rejected for the LTD insurance.
Most working individuals including federal employees do not own LTD insurance policies. The most common deterrent for buying LTD insurance is premium cost. Depending on what age an individual applies for LTD insurance is a major factor in determining premium cost. Younger applicants in their 20’s or early 30’s pay much less in premiums compared to those applicants in their late 40’s and early 50’s. Applicants for LTD insurance can expect to pay in annual premiums on average anywhere from 1 to 3 percent of their annual gross salary.
Individual LTD insurance is generally considered to be more customizable than SSDI. Many DI insurance features can be modified to help lower premium costs. For example, the waiting/elimination period can be longer compared to the 5-month waiting period associated with SSDI.
One advantage of getting an individual LTD insurance policy has to do with the amount of income the insured can receive and the relative ease of qualifying for benefits. In a professionally designed LTD insurance policy, the benefit amount ideally will be about 60 to 80 percent of the insured’s after-taxed income. This assumes that the insured is paying the premiums, using after-tax dollars. The result is that if the insured qualifies for benefits, then all benefits are tax-free. In other words, the insured will receive the same amount of income that the insured would have received in net after-taxed salary. This assumes the individual was in a combined federal and state marginal tax bracket of 20 to 40 percent. Note that as much as 85 percent of SSDI is includable in income.
Another choice that individuals applying for LTD disability insurance is the choice of an own -occupation definition of disability or an any-occupation definition. The premium cost for own-occupation is more than the premium cost for any-occupation LTD insurance Some DI insurance companies offer a number of options under their own-occupation definition of disability. These options include:
- True Own-Occupation. If an individual cannot work in his or her regular occupation but is willing to work in some other capacity, this occupation definition means that the individual can receive the full disability monthly benefit while holding another type of job. For example, if an engineer who needs his or her hands in order to use a computer or operate machinery loses his or her hands in an accident, then if he or she could take a teaching or consulting job will still receive the DI insurance benefits for the entire benefit period.
- Modified Own-Occupation. This definition pays a full monthly disability insurance income benefit if the insured individual cannot work in his or her regular occupation and is not gainfully employed in another capacity. Accordingly, the engineer in the previous example would receive benefits as long as he or she was not earning a salary. However, if the individual did get a job and earned a salary, then benefits would stop.
The benefit period provides another means of controlling premium costs. LTD insurance policies can have a benefit period as short as two years or it can be as long as the insured’s 65th birthday. Needless to say, the longer the benefit period, the more expensive the insurance.
Some LTD insurance companies will reduce an LTD policyholder’s premiums if the LTD insurance policy is coordinated with SSDI benefits. Of course, the insured would have to qualify for SSDI.
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Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
