The Guide to Disability Insurance
Disability insurance provides income replacement for those who are unable to work. However, it is not enough to just stop going to work to receive income replacement. It must be medically determined that you cannot work by a professional.
Short term disability insurance is provided to employees in Canada through Employment Insurance (EI), which provides a taxable benefit up to about $550 per week for the short term. For those who are self-employed, EI is not automatic. You can opt-in to paying into EI to get coverage, but will be required to cover both the employee and employer portion as a participant (totaling 3.888% of gross earnings).
Long-term disability insurance is often included in group benefits packages. In some cases, premiums are paid by the employer and do not represent a taxable benefit. However, if you were to receive payouts from the insurance, these would be taxed as income. In other cases, the employer may enrolls you in a group disability insurance plan but deduct the premiums from your paycheque. While this coverage comes out of your earnings, if you were to ever receive benefits from the plan, you would receive them tax-free.
Likelihood of Disability
According to the CLHIA, the not-for-profit that represents the life and health insurance industry in Canada, 1 in 3 people will be disabled for 90 days or more at least once during their working life. Due to the likelihood, it is important to understand exactly what your coverage is, for how long, and whether it would provide a taxable or non-taxable payout in the event of a disability.
Maximum Coverage Rule
As disability insurance typically provides a tax-free monthly benefit, insurance companies are not allowed to insure an individual for more than their regular earnings. This is usually about 67% of gross (pre-tax) earnings. The intention behind the coverage is ultimately to replace lost income in the event of a disability to allow a company to meet their life’s needs. Higher levels of coverage would mean that someone could receive more during a disability than they would working. Regulators see this an undue pressure to claim for disability, and they do not allow it.
Typically, you have the option for disability benefits of 2 years, 5 years, or until age 65. You decide how long at time of application. The longer the period, the more potential coverage and the higher price. “Upgrading” from a 5 year benefit period to one that covers until you reach age 65 could provide disability payments for decades more, and usually has a relatively small price increase. You should always ask about this price difference if applying for long term disability insurance.
Any Occupation vs Regular / Own Occupation
The any occupation definition of disability means that you would receive disability benefits if you could not do any work which you are reasonably qualified to do. The stronger guideline of regular or own occupation would allow you to receive disability benefits if you were disabled so that you could not perform the duties of your current work.
As an example of own occupation coverage, a doctor could recover somewhat from their disability and work as, say, a lecturer after a year of disability but never return to their regular medical work. They would continue to receive full disability benefits for as long as they could not work as a doctor.
Many workplace group policies will provide own occupation coverage for only the first two years of the benefit period. If participants were disabled beyond the two years, they would have to meet the less strict any occupation definition of disability. Even if they have coverage until age 65, after the 2 year period many would stop receiving disability benefits because there is work that they could reasonably do, even if it was not their past work which may have paid more.
Waiting (“Elimination”) Period
The elimination period will likely have a greater impact financially than the actual benefit period, depending on the length of disability. The options are:
– 30 days
– 60 days
– 90 days
– 120 days
– 180 days
– 365 days
– 730 days
The shorter the period, the sooner disability benefits would be paid out given a disability. Consequently, premiums are higher for shorter periods, especially for just a 30-day waiting period.
We recommend all households have an emergency fund in savings representing 3-6 months of expenses. This allows families to “self-insure” those first few months and only depend on disability insurance beyond that. In this case, a 120-day waiting period would be more affordable and suitable.
The 365 and 730 day periods are offered as a way to complement existing coverage. If you have coverage, through work or otherwise, that gives coverage for 2 years, you could reasonably “top up” that coverage. A policy providing coverage until age 65 with a 730 elimination period would be considerably cheaper because of such a long elimination period, and the workplace plan would kick in first.
Inflation Indexed Benefits
On individual plans, you can opt for benefits being linked to inflation. With group plans, this is often the default. This means that if you are receiving disability benefits, each year the benefit amount would be increased to match the rate of inflation. Given 20 years of payouts from a disability plan, inflation adjustments can make a huge difference. Shorter disability periods would not be as impacted by the rate of inflation.
2 Types: Non-Cancellable & Guaranteed Renewable
Non-cancellable plans cannot be cancelled by the insurance carrier and the premiums are guaranteed to stay the same for the contracted period. In addition, and most importantly, full financial underwriting is completed at time of application. If an individual goes on to lower their income and taxes through incorporating or by other means, their benefit amount will never change.
On the other hand, guaranteed renewable plans must be renewed by the insurance carrier, but the carrier is contractually allowed to increase the premiums on plans for everyone in a certain group. Individual premiums cannot be adjusted but an insurer could, for example, raise the premiums due for all plumbers if they’ve experienced higher than expected disability claims from plumbers.
Naturally, with fewer privileges given to guaranteed renewable plan owners, the cost of these is less than non-cancellable policies. For younger people with longer working years and potentially widely fluctuating incomes throughout their careers, the value of non-cancellable is pronounced.