By Jim Edholm

Long-term disability may be the most important benefit your employees have- and the most underutilized.

This is because restructuring LTD benefits is often seen as a costly, baffling ordeal that ends up benefiting neither party, though the opposite is true. Nevertheless, there are several ways that you can restructure your LTD policy to improve the coverage of your employees, while simultaneously lowering your costs and not changing carriers.

Without the ability to work, an employee's other assets- home, car and investments- disappear quickly. One survey suggests that disability is six times more likely than a spousal death to cause a bankruptcy claim and is responsible for half of all bankruptcies.

Yet far fewer companies provide an LTD benefit than they do other benefits. In fact, more than 60% of all employees have health insurance via their employer, but only 28% have LTD insurance, according to the Bureau of Labor Statistics.

Typically, LTD costs about one-quarter to one-half of 1% of payroll, and the average employer cost in 2005 was $228 per employee per year. That's not a terribly expensive benefit, particularly when compared to health insurance. But claims occur infrequently, so LTD coverage seems expensive, and smaller firms often can't afford the extra costs.

But LTD is a very popular benefit even when offered on a voluntary, employee-pay-all basis, outdrawing all other voluntary benefits, according to a 2006 survey by Aon Consulting.

That combination of popularity and infrequency suggests that offering LTD might make you a more attractive employer, able to snag the most qualified employees, reduce turnover and improve efficiency, even if only slightly.

LTD enhances productivity by helping to get the disabled employee back to work sooner.

Today's LTD policies include workplace accommodation benefits, training, counseling and other assistance to help your employee return to work. He or she comes back sooner, so you're not stuck for a longer period, paying a less efficient worker while awaiting the disabled employee's return.

Unfortunately, most employers pay more for LTD- and give their employees less- than they might, not because their broker didn't shop the policies, but because their broker didn't help them structure their plan properly.

'Taxes are the key'

What would the best structure be? Taxes are the key. Tax law says that, if the employer pays the premium, which most do, the premiums are deductible to the employer and nontaxable to the employee. However, any benefit received by a disabled employee is taxable.

On the other hand, if the employee pays the premium himself, the disability benefit is not taxable income. By paying the premium, the employer gets the lowest rate.

The carrier discounts the premium for several reasons, mainly because there isn't any adverse selection (where only the sick people buy the coverage), since all eligible full-time employees must be covered. The benefit is taxed, so the employee, as a result of his greatly reduced take-home pay, is anxious to come back to work, and the carrier discounts the premium even more.

Assume a $40,000-per-year employee and a premium of one-third of 1% of compensation. The premium is $132 per year, or $11 per month.

The employee is probably in the 15% income tax bracket and also pays a 7.65% FICA tax. Assume a 5% state income tax and ignore the Medicare tax, since it's small. So the employee takes home about $575 per week.

If disabled, his policy will probably pay him 60% of his predisability income, or $24,000. If his spouse works, he'll usually remain in the 15% bracket and still pay FICA and state income taxes. So his gross pay will drop to $24,000, and his take-home pay will decrease to $344 per week- a reduction of $231 or 40%.

Now, do it differently: The employer still pays the premium but taxes it to the employee as a noncash item. The employee is considered to be paying for the LTD. The employer reduces the benefit percentage to 50% of salary, instead of 60%, to reflect the tax-free nature of the benefit.

Here's the impact on the employer's premium: The plan is no longer noncontributory, i.e., employer-paid. The employee has the right to opt out of the plan. Adverse selection becomes a problem, and the premium increases by about 7%. The employer has to pay matching FICA taxes on the premium, adding 7.65%. The premium will drop by about 20% because of the reduction of benefit from 60% of salary to 50% of salary.

The net result for the employer? A cost reduction of 6% to 9%, considering all tax and premium changes.

And for the employee? When he files his annual income tax return, he will see the equivalent of a $0.65 weekly reduction in his take-home pay from the income taxes and FICA taxes on the premium. That's $34 a year.

But if he's disabled, his take-home benefit will be $384 a week- a $40 increase in benefit, which is almost 12%. You spend less; he gets more.

A pretty good deal for everyone, all accomplished by understanding and using the tax code.

Jim Edholm is a benefits broker and president of Business Benefits Insurance (BBI), an employee benefits planning firm in Andover, Mass.