If you experience an injury or illness that means you’re out of work either for an extended period or even permanently, if you have long-term disability coverage, it may provide you with monthly payments. Another option is to receive one lump-sum payment.
There is a lot to know if you’re considering going the lump-sum route, some of which is highlighted below.
The Basics of a Lump-Sum Disability Settlement
The general concept of a lump-sump disability settlement is fairly simple. Your insurance company pays your full disability benefit right away with one check. This is as opposed to the other option, which is receiving your payment at intervals over time. Most people who receive their benefits at an interval receive money each month.
If you’re offered a lump-sum, then it means your insurance company has calculated what they think the value of your claim is. The calculation is most likely going to be favorable for the insurance company.
That’s why it’s important to do your due diligence before accepting a lump-sum payment.
Present Value
When your insurance company offers you a lump-sum they are paying you the present-day value for your disability benefits.
If you receive payments, then they will likely be worth less over time due to inflation.
If you got all of your lump-sum settlement now, you might be able to invest it or put it in a high-yield savings account and earn interest to protect yourself from the value erosion stemming from the effects of inflation.
However, there’s a discount rate applied if you take a lump-sum.
The insurance company is paying a present discounted value.
The present value of your money, or the value it has today, goes up as the discount rate goes down, so they’re inversely correlated figures.
An insurance company is going to try to use a high discount rate in the calculation of a lump sum.
Mortality Assessment
There’s something called a mortality assessment to be aware of when considering a lump sum payout.
An insurance company will consider whether or not your disability leads to a higher likelihood of you dying before your benefits end.
The insurance carrier assesses risk based on the specific injury or illness.
Long-term disability insurance benefits are usually paid until your Social Security Normal Retirement Age or 65. Insurance companies may want to take advantage of the potential that you won’t live to receive your full benefits when they negotiate.
Tax Implications
If you’re weighing a lump sum, there are tax implications. If you paid for your long-term disability insurance premium with after-tax dollars, then your disability benefits should probably be tax-free.
If your employer paid for your premium as an employment benefit or you paid with pre-tax money, then your benefit is probably taxable at the same rate as income tax.
If you receive a lump-sum settlement and your benefits are taxable, it could be that you have to pay quite a bit on that money, making it a bad financial choice compared to receiving payments at regular intervals.
What Should You Consider?
There are some pros and cons of both taking a lump-sum buyout or receiving regular payments.
One big perk of the buyout is that it may keep you from getting denied from your benefits, or from having your claim be terminated.
When you receive long-term disability benefits, you often have to show documentation from your health care providers to prove you still need them. With a buyout, you don’t have to worry about that.
You can also get a sense of peace of mind if you go with a buyout, and another benefit was touched on above—you can invest the money.
Once a buyout or settlement is complete, you don’t have any rights against the insurance company, and you don’t have a disability claim anymore.
The biggest factors to keep in mind when you decide whether or not to settle a claim include your age and life expectancy, what your other sources of income are, and your financial security. You’ll also need to think about the likelihood you could return to work, and the strength of your claim, as well as the offer itself and how reasonable it is based on all the factors.
If you’re dealing with a long-term disability insurance claim, you probably want to speak with a lawyer who can go over the specifics of your situation and help you figure out the option that’s going to be best for you long-term.
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