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This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.
On July 1st Harold suffers severe spine and brain injuries as the result of a horrible motorcycle accident that leaves him in a coma. Doctors do not feel he will survive beyond a year.
Harold has group long-term disability insurance with a 30-day elimination period, and a benefit of 40% of Harold’s gross salary of $10,000 per month, payable until age 65. The group policy has a split definition of disability, with “own occupation” for 2 years and “any occupation” to age 65. Harold’s employer pays 60% of the premium and Harold pays 40%.
Harold also has an individual disability income insurance policy with a flat $2,000 per month benefit, 90-day elimination period, with benefits payable to age 65. This policy also has a split definition of disability with own occupation for two years and a modified definition to age 65. Harold pays for this policy himself with after-tax dollars each year.
Harold’s most recent statement from Social Security shows an estimated disability income benefit of $1000 per month.
Assuming Harold is in a 22% marginal income tax bracket, what will be Harold’s aggregate net after-tax disability income benefits in the year the injury occurred?
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Correct answer: The net after-tax aggregate amount for this year is $24,173.
Instructor insight:
Group policy: After a 30 day elimination period, the policy will pay $4,000 per month for 5 months his year. The total for this year is $20,000. Sixty percent of the benefits, $12,000 is taxable at 22%. Taxes total $2,640. The net after tax amount this year is $17,360.
Individual policy: After a 90-day elimination period, the policy will pay a benefit of $2,000 per month for 3 months this year. The total for this year is $6,000 The policy is paid for with after-tax dollars, therefore, there is no tax.
Social Security disability: After a 5-month waiting period, Social Security will pay a disability benefit of $1,000 for one month this year. Because of Harold’s income 85% of the benefit, $850, is taxable at 22%. The tax is $187, resulting in an after-tax benefit of $813 this year.
$17,360 + $6,000 + $813 = $24,173
CFP® Exam insight: The Exam will likely ask a similar question. Break each coverage down individually to identify the amount of benefit, the term, and the tax treatment. The information about coverage may be presented in a table as part of a case study.
This question is complicated. Let's hope you get lucky and your question(s) only asks about two types of coverage.
