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Short Term Disability Insurance vs. Long Term Disability Insurance

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When it comes to voluntary benefits, knowing what to offer your employees may be challenging. For your employees, understanding the right coverage types and levels can be overwhelming; in the event that they experience a disability, they may not have adequate coverage in place.

To ensure you and your employees have adequate protection in place when such incidents occur, it's important to explore the differences between short term disability and long term disability.

What is disability insurance?

Disability insurance is a special type of insurance that protects your ability to earn a paycheck in the event that you experience a serious illness or injury. Disability insurance is not designed to provide benefits if you miss a week of work due to the flu. Instead, it provides coverage after a predetermined waiting period (called the elimination period) for conditions that would keep you from working for extended periods of time. Disability insurance is generally categorized as short-term and long-term, and each type of insurance has unique benefit periods, elimination periods, and benefit amounts.

 

Short-term Disability

Long-term Disability

Average Time Benefits Can Be Used

Typically 3, 6, or 12 months

Typically 2, 5, or 10 years; can be for life on some policies

Elimination Period

7-30 days; 14 days is most common

90 days on most standard policies; insured can choose a longer elimination period to lower premiums

Benefit Amount

40-70% of lost wages

60-80% of lost wages

Average Cost of Coverage

1-3% of your pre-tax salary

1-3% of your pre-tax salary

Where to Get Coverage

Employer-sponsored plans, supplemental policies, or private coverage

Employer-sponsored plans, supplemental policies, or private coverage

What is short-term disability?

Short-term disability is a type of voluntary insurance that replaces part or all of an employee's income in the event of a temporary disability. Typically, this insurance policy is paid in full or in part by the employer, and the employee must be unable to perform their normal work duties, due to illness or injury, to qualify for benefits under the policy.

Although this coverage may seem similar to workers' compensation coverage, the two coverage types have very different applications. Workers' compensation provides coverage when the illness or injury occurred at work or as a direct result of work activities, whereas short-term disability will provide coverage even when the employee is injured outside the workplace. Generally, an employee cannot qualify for benefits under both workers' compensation and short-term disability for the same incident at the same time.

How does short-term disability insurance work?

Short-term disability is designed to protect both the employee and the employer if the worker can no longer do their job as a result of illness or injury. When a qualifying event happens, an employee can file a claim with a disability insurance company to receive the amount of income specified in the policy benefits. This helps to protect the employee from financial hardship during the recovery period by providing temporary income for routine expenses.

Short-term disability also benefits the employer. The policy helps to protect the employer's investment in a valuable employee by ensuring the employee can remain financially stable long enough to recover and return to work. Since disability benefits are paid by the insurance company and not the employer, this also provides financial flexibility that would allow the company to pay for a temporary replacement without incurring excessive labor costs.

Some states, such as California and New York, require employers to provide short-term disability coverage to all employees, along with other employee benefits required by law. The state may provide a state-sponsored disability plan, or employers can purchase one through a private carrier. In these states, there are many rules that regulate short-term disability, so employers should carefully review any regulations that may apply.

What qualifies for short-term disability and what does short-term disability cover?

To qualify for short-term disability benefits, an employee must be unable to do their job, as deemed by a medical professional. Medical conditions that prevent an employee from working for several weeks to months, such as pregnancy, surgery rehabilitation, or severe illness, can qualify to receive benefits. Since employers in most states must legally provide workers' compensation insurance to all employees, any injuries incurred on the job are typically covered under a workers' comp policy and are therefore not eligible for short-term disability.

While most non-work-related temporary medical conditions are covered by a short-term disability policy, there can be exclusions for preexisting conditions or intentional and foreseeable injuries (such as those inflicted during the commission of a crime). While employees can qualify for time off under the Family and Medical Leave Act (FMLA) to care for a sick relative, most short-term disability policies would not provide benefits if the covered employee is not the one with the illness.

When do short-term disability benefits start?

Once a claim is filed, there's usually a short waiting period — the elimination period — of one to 14 days before an employee can begin collecting benefits from the policy. The waiting period will be specified in the policy terms during signup. For most disability claims, the employee must provide a medical form signed by a doctor that details the illness or injury. The form asks for the first date of illness or injury, and this date is typically used as the beginning of the elimination period.

How long does short-term disability last?

While benefit periods may vary across different providers, most short-term disability policies provide benefits for three to six months. Some policies, especially those connected with a long-term disability policy, may provide short-term coverage for a full year. If an employee needs additional coverage beyond the initial short-term disability period, a long-term disability policy may be needed to extend the benefits.

Is short-term disability taxable and how much does it pay?

Income from a short-term disability policy may be taxable, depending on whether it was funded with pre-tax or post-tax income. Most employer-sponsored disability plans are paid on a pre-tax basis either directly from the employer or through payroll deduction from the employee (or a combination of both). In these cases, the insurance proceeds would be taxable, since taxes were not paid on the income used to fund the policy. In contrast, if an employee purchases a private disability policy outside of the employer's benefits plan, this would be purchased with post-tax income, and the disability benefits would not be taxable.

The actual amount paid out in benefits on a short-term policy is typically 40-70% of the employee's earnings for the covered event period once the elimination period has passed. The employee may opt to have taxes deducted from the benefits check (if applicable) to avoid a tax liability at the end of the tax year on any disability benefits paid.

What is long-term disability?

Long-term disability is an insurance plan that often works in tandem with short-term disability to provide income for long-term illnesses and injuries. Once short-term disability benefits are exhausted, a long-term disability policy continues to provide the employee with some income until they can return to work.

How does long-term disability insurance work?

Long-term disability works in much the same way as short-term disability. Once a plan is in place, the employee must provide medical proof of a qualifying illness or injury lasting beyond the long-term disability elimination period. Once the burden of proof has been met, the employee can begin receiving the benefits specified in the policy. Benefits will continue until the employee is medically cleared to return to work or has exhausted the policy benefits.

What qualifies for long-term disability and what does long-term disability cover?

The qualifications for long-term disability are usually more stringent than those for short-term disability. With short-term disability, benefits can be awarded if the employee is unable to do their job. With long-term disability, benefits will typically only be awarded if the employee is unable to do any job. What constitutes a qualifying event will be specified in the policy, so it is important to understand when benefits may (or may not) apply before accepting a long-term disability policy.

Qualifying events may include chronic pain, cancer treatments, or debilitating illness or injury lasting more than 26 weeks. If an employee could qualify for another form of income replacement, such as Social Security Disability Insurance, the long-term disability policy will no longer provide benefits.

When do long-term disability benefits start?

Long-term disability benefits begin after the specified waiting period and any coordinated short-term disability benefits have been exhausted. If an employer offers both short-term and long-term disability plans through a single insurance provider, the provider will usually pay out under the short-term disability plan to its maximum before applying long-term disability payments, even if the specified long-term waiting period is shorter. For cases where a short-term disability policy may not apply, the standard waiting period for long-term disability policies is three months.

How long does long-term disability last?

Once long-term disability benefits have been approved, an employee can continue to receive benefits for the length of the policy term or until they return to work. Most long-term disability plans provide coverage for 36 months, although some plans can provide coverage for up to 10 years or even for the life of the policyholder.

Is long-term disability taxable and how much does it pay?

As with short-term disability benefits, long-term disability benefits may be taxable depending on how the policy is funded. If the policy is paid through pre-tax payroll deduction, the employee will likely be liable for income taxes on any and all long-term disability benefits. The covered employee can also opt for taxes to be deducted as each benefits check is processed, or they can resolve any tax liability related to long-term disability benefits at the end of the tax year.

What are the elimination periods for long-term disability?

The most common elimination period for long-term disability is 90 days, but the exact terms of the elimination period will be specified in the policy. If short-term disability coverage is available, the effective waiting period before receiving benefits will be relatively short. When a short-term policy is not available, however, employees may have to wait several months with no income before qualifying for long-term benefits. Due to the longer elimination periods, many employees opt for a combination of short-term and long-term disability coverage.

Short-term disability vs. long-term disability insurance

The main difference between short-term and long-term disability insurance is the length of coverage. Short-term policies are designed to provide benefits almost immediately for temporary disabilities, while long-term policies have a considerably longer waiting period, but they provide coverage over a longer term for more serious illnesses or injuries. Additionally, long-term coverage benefits tend to be a higher percentage of the employee's salary since the qualifying illness or injury has a more significant impact on the employee's ability to generate income. Since insurance companies may potentially provide benefits for years with a long-term policy, the medical requirements are also more rigorous. The employee must be unable to perform nearly any kind of work to qualify for benefits.

Should I purchase short-term or long-term disability insurance?

Although illnesses and injuries can't be predicted, they're likely to affect your workplace at some point in the future. For comprehensive protection, employers may consider offering a combination of both short-term and long-term disability insurance to employees. These policies are an important complement to any group health insurance plan and help to minimize the impact of debilitating illnesses and injuries on both your employees and your business.

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* This content is for educational purposes only, is not intended to provide specific legal advice, and should not be used as a substitute for the legal advice of a qualified attorney or other professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up-to-date.

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