Updated: Sep 16, 2020
Earlier this week, in Part 1 of our 2-part series, I explained that if your employer pays premiums on a long term physician disability income policy with funds not included in your income checks, your benefit amounts (including lump sum settlements) will be taxed during your disability claim. While they do tend to be an attractive option due to the savings you receive by paying with pretax income, the reality is, in the long run, you’re not saving much, if anything.
Here’s an example.
An Example: Do the Benefits Outweigh the Costs? Let’s consider a physician disability insurance premium of $5,000 per year for a $120,000 benefit. By opting for pretax payments you will likely save $2,000 per month. However, in one year of being disabled, rather than receiving the $120,000 in benefit payments, you will only receive about $80,000 (based on 1/3 going to taxes) after taxes. On the other hand, by paying with post tax, your yearly payments will represent the full $5,000 per year, but you will receive the full $120,000 per year that you are disabled. So, for both scenarios, let’s look at purchasing disability insurance starting at age 35 and becoming disabled at age 60, for one year and for two.
YEAR ONE By age 61, you will have paid $75,000 by opting for pretax payments and receive $80,000 for that one year of disability. That is a net gain of $5,000. By paying post tax, your total premiums will have reached $125,000 and you will have received $120,000 for that year of disability, a net loss of $5,000. This represents a $10,000 difference in favor of pretax payments.
YEAR TWO By age 62, you will have paid $75,000 by opting for pretax payments and receive $160,000 for 2 years of disability. That is a net $85,000 gain. By paying post tax, your total premiums will have reached $125,000 and you will have received $240,000 for that year of disability, a net $115,000 gain. This represents a $30,000 difference in favor of post tax payments. Every following year, the difference will grow another $40,000 in favor of a post-tax disability plan.
So the question becomes, are you really willing to wager $30,000 that if you are disabled, you will only be disabled for no more than one year? The cold hard reality is, you are buying disability insurance because you are betting on the chance that you will become disabled over the course of your practice. So why risk saving a little now, when the purpose of this product is to know you will maintain your lifestyle for the duration of your disability? This is NOT an instance where you want to hedge your bets.
Solve the Problem Individual disability insurance is powerfully associated with the medical and legal professions. The maximum monthly benefit available to physicians is up to $30,000. We are happy to provide a free and quick policy review or consultation at your convenience.