When discussing disability insurance, particularly as it refers to highly-compensated employees and professionals, there appears to be a distinct lack of understanding of the mechanics of disability income insurance coverage. Whether it's an office worker or an executive, almost everyone says, "I didn't realize that."
Corporate executives, business owners, money managers, lawyers and others firmly believe that they are adequately protected and that their company's disability income plan provides them with 60 percent coverage. In other words, they are firmly convinced that, should they become disabled, they will receive 60 percent of their annual compensation. That is their perception. Unfortunately, in the world of disability benefits for highly-compensated individuals, perception is definitely not reality.
Recently I met with the head of the human resources department of a large public company, and soon the conversation turned to a discussion about their disability insurance coverage.
"So," I asked, "how much disability insurance does the company provide for its employees?" He replied, "We offer 60 percent income replacement to a maximum of $20,000 per month of benefit, so our employees earning up to $400,000 are fully protected."
I thought about his response for a moment, and then asked, "So, if I earn $250,000 of base salary and $150,000 in bonuses for a combined total of $400,000, I would be protected at 60 percent. Correct?"
He thought about my question and answered, "No, actually, only base salary is covered under our group disability plan."
His response further solidified what I've discovered after talking with a number of companies. And that is the disturbing fact that, for many companies, its group disability coverage only provides 60 percent of base salary, with no protection for bonus income. This means that many employees have significantly less coverage than they think.
Let's look at a hypothetical example. The vice president of sales for a consumer products company makes $400,000 per year, which includes a base salary of $250,000 and a bonus of $150,000. He is suddenly hospitalized for complications from diabetes and he goes out on long-term disability. It's his belief that his monthly disability income will be $20,000 per month ($400,000 x 60% divided by 12 months). Think of his surprise when a monthly check shows up in the amount of $12,500 ($250,000 x 60% divided by 12).
In this case, the key question that employees need to get answered is: "60 percent of what?"
- Is it 60 percent of base salary?
- Is it 60 percent of base salary, plus the annual bonus?
- Is it 60 percent of base salary, plus annual bonus and long-term bonus?
- Are the benefits taxable or tax free?
- What is the monthly benefit cap? Is it $15,000, $20,000, $25,000 or $30,000?
There are many different ways benefits are calculated, so this can be both complex and confusing. Some employees are covered at 60 percent of compensation, while others are actually covered for as little as 20–30 percent of their net take-home pay after taxes.
Let's look at another scenario.
