While, hopefully, your disability policy will provide sufficient income to meet your essential expenses if you have to file a claim, benefit amounts rarely provide monthly income that is comparable to what you earned while practicing. Additionally, many policies have maximum benefit periods that expire at age 65 or 67, which means you will be without a monthly income for the remainder of your life if you haven’t established other financial resources. As we’ve discussed in previous posts, one option to ensure continued financial stability is to purchase a policy that includes lifetime benefits rider. Another option we are beginning to see offered with some policies is the lump sum disability rider benefit.
This rider is designed to provide a one-time lump sum payment at the end of the benefit period, much like being able to access a 401(k) or other retirement account upon reaching retirement age. This lump sum can also help to offset expenses that may be more likely to arise later in life, like the costs of needed surgeries or other medical care.
While lifetime benefits work by paying a claimant a continuing monthly benefit after the normal expiration date of a policy, under this type of rider, the insurance company pays a one-time payment at the end of the policy’s benefit period. The payout will typically be a certain percentage of the benefit payments the policyholder received prior to the end of the maximum benefit period under the policy. This calculation includes payments received both while on total disability and residual disability, over the life of the policy, whether continuous or not.
For example, say a claimant received a monthly benefit payment of $5,000 per month (or $60,000 per year) and remains on claim from age 48 to the end of the benefit period (age 65, for example) or 17 years. If the lump sum benefit is equal to 35%, the claimant would receive a one-time payment of $357,000 (17 x $60,000 x .35).
It is also important to note that these riders typically require that a claimant receive a minimum threshold amount of benefits to qualify to receive the lump sum payment. For example, the qualifying amount may be set at $60,000. If the monthly benefit payment is $5,000 a month, the policyholder won’t be eligible for a lump sum payment unless he or she remains on claim for at least 12 months over the life of the policy.
Thus, with a lump sump benefit rider, the longer a policyholder stays on claim, the larger the lump sum payment will be. It therefore stands to reason that insurance companies have an even stronger than normal incentive to get a claimant off claim. As insurance companies often use aggressive tactics to investigate claims in order to find justification to terminate or deny claims in an attempt to save money, having a lump sum benefit rider could result in greater scrutiny of a policyholder’s claim, particularly before the qualifying amount is reached. However, unlike lifetime benefit rider options (which typically require a policyholder to continue to submit proof of loss for life in order to continue receiving lifetime benefits), the insurance company’s ability to scrutinize a claim ends upon the payment of the lump sum under a lump sum benefit rider.
Thus, as with all policy provisions, there are pros and cons to keep in mind, and deciding whether the lump sum disability benefit rider is the right policy for you requires careful consideration of what you can afford in premiums, your age, other sources of income you and your household have, and your plans for retirement.
The new year is often a time for making resolutions and planning for the future. This should include reviewing your financial situation, including assessing whether you will be adequately prepared in the event that you become disabled and have to stop practicing. We recommend that you make a periodic review of your disability policies and evaluate:
- What type of policy(ies) do I have?
- Do I understand the terms and provisions of my policy(ies)?
- How much coverage do I have?
- Do I have enough coverage?
- Do I qualify for any increase options?
- Should I buy an additional policy(ies)?
Many physicians and dentists purchase their policies as residents or when they are first establishing their practice, and then file their policies away and don’t think about them again until the unexpected happens and they need to file a claim. This is problematic, because financial needs and obligations change over time, and the income and standard of living for a resident is vastly different than that of a physician with a family 20 years down the road.
While insurance companies’ underwriting standards are typically structured in a way that prevents you from collecting the exact same amount of monthly income you were making pre-disability, your goal should be to get as close as possible. In other words, if you are a dentist earning $20,000 a month and need to file a claim, you don’t want to have to end up relying on a disability policy with a monthly benefit of $5,000 as your primary source of income.
Often policies have future increase options that allow you to purchase additional coverage without changes to the terms of the existing policy. Typically, these options will only be available during certain discrete time periods set forth in the policy, so it’s important to read your policy carefully to make sure you don’t miss out on the opportunity to take advantage of an increase option.
If your policy does not have increase options and you’ve outgrown the monthly benefit amount, you can also purchase another policy to increase the total coverage you would receive if you filed a claim. However, if you’re going to be purchasing a new policy, you need to keep in mind that you must purchase a policy that compliments you’re existing coverage, and does not cancel out your other policy or policies.
For example, some policies contain provisions stating that a claimant cannot collect total disability benefits if he or she is working in another profession (a “no-work” provision). Other policies require the policyholder to work in some other capacity, in order to collect total disability benefits (a “work” provision). Thus, if you were to purchase a new policy with a “work” provision, and your old policy had a “no work” provision, one of the policies would be rendered useless (because it would be impossible to collect total disability benefits under both policies).
When purchasing a new policy, it’s also important to keep in mind that disability policies have become increasingly more complex, restrictive and less favorable to policyholders over time. There is no longer a “standard” policy that every company sells—each policy will have it’s pros and cons, and it is therefore important to take your time to familiarize yourself with the policy at the point of sale, so that you know what you’re purchasing. And if you didn’t pay close attention when you purchased the policy, or you can’t remember exactly what your policy says, you should review your policy to assess whether it still meets your needs and make sure that you have an accurate understanding of the scope of your coverage.
The Answer Is: It Depends
Whether your disability benefit payments are taxable depends on what type of policy or plan you have and how your premiums are paid. This post is not intended as tax advice—we’ve outlined some basic information below only. You should always speak with a tax professional regarding your particular situation.
Individual Policies: These are policies that you purchase yourself. Generally speaking, if you pay the premiums with after-tax dollars, the benefits you receive are tax free. However, if you pay with pre-tax dollars or deduct your premiums as a business expense, then your benefits will likely be subject to federal income taxation.
Group Policies: Group policies are those offered through associations such as the ADA or AMA. These types of policies offer special terms, conditions, and rates to members and function much like individual policies, with similar tax consequences. Generally speaking, if you pay the premiums (with after-tax dollars) then the benefits you receive are tax free.
Employer-Sponsored Policies: These types of policies can be less straightforward when it comes to taxes, as the payment of premiums can be structured several ways. According to the IRS website:
- If your employer pays the premium and does not include the cost of the premiums in your gross income, then benefits you receive will generally be fully taxable.
- If the employer only offers a policy, but you pay the entire premium without taking a tax deduction,
then the benefits you receive will generally be tax-free.
- If both your employer and you pay the premiums then the tax liability will generally be split.
If you are unsure what type of policy or plan you have, and you think your employer might be paying the premiums, you can look at your application (there is typically a portion that states who is responsible for the premiums) or talk to your HR department. For more information, talk to your accountant. You can also go to to the IRS website on disability insurance proceeds to find additional information.
It may be tempting to save money by enrolling only in a plan solely paid for by your employer, paying premiums with pre-tax dollars, or deducting premiums as business expenses. But keep in mind that, if you do become disabled, the amount of your benefits actually available to you will substantially decrease if you are required to pay income tax on them.
Selecting a policy is an important decision, and how benefits will be taxed is a significant factor to consider. With statistics showing that one in four dentists will be disabled long enough to collect benefits at some point in their careers, choosing to save now could hurt you financially down the road.
Unum announced last week that Jack McGarry, former CEO of Unum’s United Kingdom arm, has been brought back to the U.S. to manage Unum’s closed block of business. This “closed block of business” includes its individual disability policies issued prior to the mid-1990s–the type of policies that Unum no longer sells. According to Unum Group CEO Thomas Watjen, Unum hopes that McGarry’s experience will benefit the company:
“Our closed block of business represents over 25 percent of our capital, and I’m confident that Jack’s significant financial and operational expertise will help us improve the performance of this business.”
Unum doesn’t explain what it means by “improving the performance of this business.” The policies McGarry will be managing aren’t sold anymore, so he can’t improve that block’s performance by changing the way policies are sold, who they are sold to, or how they are priced. And at this point, Unum has to honor the outstanding policies as they are written, so he can’t lawfully help the block improve performance by skimping on benefit payments.
Watjen’s statement could mean that McGarry, who has discussed Unum’s confusing policy language in the past, will help the individual disability department better serve customers by making Unum’s communications easier to understand. However, it is also likely that “improving the performance” of that block of business means that McGarry will focus the company’s efforts on continuing to scrutinize claims made on the individual policies to avoid paying benefits (and thus save Unum money). Either way, our disability insurance attorneys will be closely monitoring Unum and any new developments under McGarry’s leadership.