Long Term Disability Coverage; Who Should Pay for it?

This is a question that we are asked frequently by our clients. Instinctively most people will believe that it is best to have the employer pay for benefits. After all, having someone else pay for things that provide you with the benefit is always best, right? In nearly all cases with non-taxable benefits provided by an employer, the employer pay scenario is the most advantageous for the employee. This single rule is not always the case. There is one situation in particular where the having the employee pay the cost of the benefit is a better deal for the employee. That case is Long-Term Disability coverage.

There is one situation in particular where the having the employee pay the cost of the benefit is a better deal for the employee. That case is Long-Term Disability coverage.

Why is this different from any other benefit?

It has to do with how the Income Tax Act treats any payment made under an LTD plan. If the employer pays the premium then 100% of any payment made under the plan is taxable to the employee. If the employee pays (or the employer deducts and pays on the employee’s behalf) then any payment made under the plan is 100% non-taxable.

So, there is a possibility of a benefit down the road, how beneficial is it?

It’s quite beneficial actually, and the benefit will come exactly when you need it, when you have an LTD claim. Here’s an example:

Let’s assume you are making 50,000 annually and LTD will pay 60% of  your salary if you have a claim.  60% of 50,000 is 30,000. The premium for this is 50 per month or 600 per year. If your employer was willing to pay the premium they would increase your wage by the amount of the premium, keeping your net take home pay the same. Over 20 years this would increase your taxable income by a total of 12,000. Your tax cost on the additional income over 20 years would be roughly 4,200 at current rates.  If the employer paid the premiums and you have an LTD claim that lasts for 3 years your tax bill would be about 22,500. If you had paid the premiums your saving would be $18,300, a 15% increase in the amount of cash you would have available for living costs. The point at which you would be even in cash terms is where you have one LTD claim that lasts for 7 months over a 20 year time span. Basically, if you use the LTD insurance at all you are better off to pay the premiums yourself.

I might not use my LTD insurance, why should I care about this?

That you consider LTD insurance (or any insurance at all for that matter) as beneficial to have shows that you have some concern about the future. After all, we have yet to hear anyone complain because they haven’t used their life insurance! In the course of running our accounting practice we see the impact of when the future becomes the present. We have clients who have needed to use their LTD plans and then have had the income taxed. When your income is reduced by 40%, that $600 per month in tax (using the numbers from the example above) can become the difference between a decent (but frugal) lifestyle and abject poverty. It is not a happy situation and one that is entirely preventable with a bit of foresight and a good advisor.

Is there anything else that I should know about this?

Yes, there is one more thing. You can’t pick and choose when the employee pays and when the employer pays. It must be a situation where the LTD is employee paid for everyone who is entitled to LTD insurance.