In this article, we examine disability insurance and the various ways that you can prepare yourself for a disability. We review government benefits for disability. We also explain common terminology that is present in group disability contracts, individual contracts. Finally, we consider an example of needing two years of disability coverage at the age of 55.
If you’re like many Canadians, you may find yourself financially ill prepared if a disability arose tomorrow.
A recent study conducted by Ipsos on behalf of RBC found that 68% of Canadian workers have experienced time away from work due to a disability. These disabilities could be for themselves, a family member, or someone they know.
Half of Canadians indicated that they don’t believe they could take a leave of absence should they need to.
There is a trend towards fewer and fewer Canadians having coverage for disability – either through work or through a personal plan.
That means that the financial strain of having to take time away from work would be very significant.
What Can You do to Prepare Yourself?
Understand Your Budget: Knowing what it costs for you to live each month and what it would take to maintain those expenses is important.
Build an Emergency Fund: Even having a small amount of money set aside to deal with unexpected emergencies can be a lifesaver. Ideally, aim for three months of expenses. Avoid using your RRSP as this emergency fund as the tax burden of withdrawing from registered accounts is significant.
Check out Your Options: Make sure you understand exactly what your group coverage looks like. Know what government programs provide (see below), and research individual options. We’ve outlined a scenario below that might help quantify building up your savings, taking out a loan in the future, or setting aside money today to pay for a potential claim in the future.
Have a conversation: Talk to your spouse, family, and friends about what would happen in the event of an injury or illness that would prevent you from doing your job.
Understanding Government Benefits
Government benefits are commonly leveraged for Short-Term Disabilities, and are less certain for disabilities or injuries that last longer than 16 weeks. The criteria and benefit amounts associated with these programs reinforces the need to have personal or group coverage in place.
Worker’s Compensation: This program is designed to cover injuries and illnesses that are derived from your workplace. If you get in a car accident on the way to work or become ill from something not caused by your workplace, this benefit does not apply.
Not all workplaces are required or decide to offer WCB coverage to their employees, but if this coverage is in place, it covers a substantial amount of your gross income.
Employment Insurance: In 2020, the maximum weekly benefit amount has been set at $573 per week. There is a one-week waiting period before benefits commence, and then the benefits are payable for a maximum of 16 weeks.
Many small companies rely on employment insurance to cover disabilities that last less than 16 weeks. If companies offer group disability insurance, the Long Term Disability portion of the plan would commence typically after 16 or 17 weeks of total disability.
Canada Pension Plan Disability (CPPD): This program is designed to provide partial income replacement to eligible CPP contributors who are under the age of 65 and who have a severe and prolonged disability.
There is a two-year waiting period for CPPD benefits to kick in.
Severe and prolonged means that a physical or mental disability prevents any substantially gainful job, and that the disability is long-term, indefinite duration, and will likely result in death. Children of CPPD recipients are eligible for a flat-rate monthly benefit up to age 18 or 25 if attending school full time.
Assured Income for the Severely Handicapped (AISH): Financial and health benefits for Albertans living with a permanent medical condition. Again, you have to be fully disabled and unable to earn an income. This program includes health benefits, but the monthly living allowance is a maximum of $1,685 in 2020.
Understanding Your Group Benefits
Many employers offer Long Term Disability (LTD) benefit plans. If these benefits are in place, over 98% of employers deduct LTD premiums from payroll.
The reason that LTD premiums are employee paid is so that any benefits derived from the plan in the form of disability insurance payments should be received tax-free.
If you have group coverage in place, it’s important to understand how the benefits work…before you need them.
There is a lot of terminology to grapple with in the context of group benefits LTD coverage. These factors all determine how much benefit would be received at the time of claim and for how long.
Benefit Formula: This is expressed as a percentage of earnings. The formula can be a flat 67% of gross earnings for example, or it can be a tiered formula.
Benefit Maximum: This is the overall maximum monthly income replacement amount that an employee could be eligible for in the event of a claim.
All-source Maximum: Disability programs are set up so that you are better off working than you are disabled. Contracts include a stipulation that disability income from all sources should not exceed 85% of your pre-disability income.
This takes into account benefits like Worker’s Compensation Benefits. It basically means that the amount you receive from a disability contract could be reduced if other benefits are in place.
For example, if your automobile insurance is paying benefits to compensate you for loss of income, then those benefits reduce the coverage in your group contract.
Non-evidence Maximum: Insurance companies spread risk to pay for the cost of potential claims. The non-evidence maximum is the amount of coverage that the insurer is willing to offer regardless of health status.
Large organizations may have very high non-evidence maximums, but smaller organizations may have a non-evidence maximum as low as $1,200 of monthly income replacement.
Individual employees must apply for benefit amounts over the Non-Evidence Maximum (NEM) by answering health questions. Make sure you know exactly how much coverage your group disability coverage provides.
Any versus Regular Occupation: A standard group insurance contract will include a clause that looks like this:
LTD benefits are payable for the first 24 months following the waiting period if disease or injury prevents you from performing the essential duties of your regular occupation. After 24 months, LTD benefits will continue only if your disability prevents you from being gainfully employed in any job.
This change to the any occupation definition of disability means that benefits cease for some claimants at that 2-year mark.
The devil is in the details in all contracts, and understanding how these definitions could impact your coverage is important.
The Need for Coverage
For some people, the absence or limits of group coverage (or any coverage at all) means that individual disability coverage is an important component of their financial security.
No one expects to become disabled, but approximately 1 in 5 of us will become disabled prior to age 65.
In the example below, we’ve used an example of Bob, a marketing consultant making $100,000. He’s 45 now, and thinking of applying for a policy that would provide $5,000 of monthly income replacement.
We talked to Bob about what it would look like if he became disabled for two years at the age of 55. His options would include the following:
Claim his disability insurance: Benefit payments would yield $120,000 over a two-year period. The premium for this coverage is about $190 monthly.
Withdraw from investments: Withdrawing from RRSPs is subject to 30% withholding tax and reduces RRSP contribution room. Depending on the types of investments and tax rates of the return you may need to put aside slightly more or less than $850 per month, but what happens if Bob becomes disabled sooner than age 55 or if the disability lasts longer than two years? He would not have accumulated enough to support himself for 2 years.
Set aside enough money today to pay for a future potential claim: Based on a 5% rate of return, Bob would need to set aside about $90,000 today.
Take out a loan: While this costs nothing today, the potential out of pocket cost for a loan at 5% interest would over $160,000.
Your ability to earn an income is likely your biggest asset and buying disability insurance is the most cost-effective way of mitigating a significant risk.
Disability Coverage Options
Individual disability contracts vary significantly. Some of the factors that impact the price include contract details. Some individual policies can limit benefits for soft-tissue injuries, benefit periods, the what defines a disability.
For people working in a professional capacity, we recommend a professional series contract whenever possible. Professional series contracts offer robust policy features that are not included in group policies or all individual policies.
Partial or residual disability: these provisions mean that you don’t have to be totally disabled in order to make a claim. If you’ve lost more than a certain percentage of time or income, then a professional series contract may provide a percentage of benefits. In group contracts, you typically have to be totally disabled.
Guarantees: a non-cancellable contract means that the insurance company can’t change your contract (even though you can cancel any time).
Return of Premium: This is an additional rider that returns 50% of premiums paid every 7 or 8 years depending on the insurer. While the rider is expensive, it’s a nice bonus for people who manage to stay healthy!
Option to buy more coverage later: this optional rider allows you to buy more insurance later as your income grows. For early- to mid-career professionals, this rider means that you can add benefits, even if a health issue arises in the future that would make you uninsurable.
Talk to us today! Make 2020 the year that you take a serious look at the potential risk of losing your income for more than three months. We can help source practical, cost-effective options that can offer you peace of mind.