According to a major provider of disability insurance, three out of every 10 workers between the ages of 25 and 65 will experience an accident or illness that keeps them out of work for three months or longer, with nearly 60% of these injuries occurring off the job.
An extended illness or injury can create significant financial hardship. If an employee is hurt off the job worker’s compensation will not cover them. When an employee cannot work for an extended period of time, a long-term disability (LTD) plan can help cover a portion of the employee’s salary so the person can continue to pay bills and medical expenses.
Although employees will often express a greater demand for more visible benefits, like paramedical or a richer dental plan, a LTD benefit is far more important in protecting the financial well-being of employees.
Very few employees will ever be forced to sell their homes because they need eyeglasses or dental work. However, a loss of income can have much more serious repercussions.
The way an LTD plan is taxed can have serious implications for an employee if they end up requiring disability.
Most LTD benefits are non-taxable. To qualify as a non-taxable benefit the employee must pay 100% of the LTD premium. If employees pay a share of the overall premium their portion is credited first to the LTD benefit.
But LTD benefits can be taxable. The most common reason this happens is that the employer pays for all the benefits. The benefit amount formula is often 75% of income versus the 67% for non-taxable plans.
A more controversial set up has the employer pay for the LTD premium and use the employee’s contribution to cover other benefits such as health and dental. The rationale behind this option is that a disabled employee will be recognized by Canada Revenue Agency (CRA) as someone who is earning an income so they will therefore have access to tax deductions under the income tax act. They will file an income tax return, continue RRSP contributions and apply for the medical expense credit.
While this sounds convincing, I am not in favour of this set up for the following reasons:
- Income tax must be deducted at the source. So a disabled employee whose employer has paid 100% of the LTD premiums would have their benefit amount taxed leaving them with less to live on while not working.
- Most individuals on disability income will not have the money to contribute an RRSP
- The medical expense credit will not be enough to offset the difference in income lost due to the plan being taxable.
In a non-taxable plan where the employee has paid the premium, CRA considers their benefit amount as already taxed so the employee will have access to a larger benefit amount. The employee will not be able to contribute to RRSP or apply for some credits, but having access to a larger benefit amount is worth the trade off. While it depends on the employee group, it is often preferable to make LTD a non-taxable by having employees pay 100% of the premium.
Photo credit: “Hit Me With Your Best Shot” by Brett Kiger on Flickr