Most Group Long-Term Disability plans have the employee paying the premiums, so that when the employee is disabled, they receive the insurance proceeds tax-free. But is that the best way?
The alternative is for the employer to pay the premiums. However, in that situation, a disabled employee will pay tax on any disability insurance benefits they receive. Obviously, if an employee is asked if they would rather receive tax-free disability payments or taxable disability payments, they will say “tax-free”.
But it’s not that simple, due to the following concept: An insurance company will allow a person to insure their income up to a certain percentage, so that it isn’t financially to their advantage to be disabled. The reason is that a disabled person collecting as much money as when they were at work, might be reluctant to attempt to return to work. That will lead to fraudulent claims.
But here’s the trick: The insurance companies use different percentages depending on whether the insurance will be “taxable when received” or “tax-free when received”. For example, if an employee’s annual income is $70,000 they are allowed to have $3950 per month of “Tax-free” Long-Term Disability Insurance. At the same income, they are allowed to have $5100 per month of “Taxable” Long-Term Disability Insurance. Under 2017 Income Tax Tables, a single person receiving $5100 per month of taxable income, will have after-tax income of roughly $4150 per month. That amount will vary depending upon each person’s tax return, but as you can see, the spendable income figures for tax-free disability insurance and taxable are very close. There is not the financial advantage to “tax-free” disability insurance that most employees perceive.
Another financial consideration is that a disabled person receiving “taxable” long-term disability benefits, can still make an RRSP contribution and deduction. This gives the disabled person more flexibility with their financial planning.
Another argument in favour of having the employer pay the premium, is that when an employee pays Long-Term Disability insurance premiums, they are doing so with after-tax dollars. And obviously not everybody is going to collect on Long-Term Disability insurance. It is very important to the small number of people who are disabled, but it is very costly to everybody else.
In most cases, the cost-benefit value is better if the employer pays the premium and deducts it as a business expense. Certainly, you want any employer to get credit from the employees for providing a Long-Term Disability plan, because it is a form of compensation, and for that reason, it doesn’t hurt to remind employees from time-to-time about the value of this (and other) benefits.