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Social Security Disability and Your Clients: The Real Story

A primer on Social Security Disability Insurance, the program’s largely misunderstood non-retirement benefit.

Financial advisors have gained more knowledge about Social Security in recent years, especially when it comes to optimizing retirement benefits through delayed claiming. But have you taken the time to understand the ins and outs of Social Security’s non-retirement benefits—especially disability? 

Most people think of Social Security as a retirement program—and when first passed into law in 1935, the principal aim was to reduce very high poverty rates among seniors. But Social Security evolved over the years as Congress added broader goals.

The program’s modern design is to protect against the risk of lost income from work—whether that results from retirement, disability or the death of a family breadwinner. Of the 61 million Americans receiving Social Security at the end of 2016, 68 percent were retired; 18 percent were survivors, spouses, or children of workers entitled to benefits; and the remaining 14 percent were disabled workers. 

Advisors should take the time, in particular, to understand Social Security Disability Insurance. A young person starting a career today has a one-in-three chance of dying or becoming disabled before reaching Social Security’s full retirement age, according to Social Security Administration data. Here are a few key points to understand about how SSDI works, and how it interacts with other key insurance benefits.

An earned benefit, not welfare. SSDI is funded through the Disability Insurance Trust Fund. Revenue for this fund comes chiefly through the payroll tax levied on workers and employers. Currently, 2.37 percent of the total 12.4 percent payroll tax goes into the disability fund, split evenly between workers and employers.

Discussion of Social Security’s long-range financial imbalance often muddles together discussion of the disability fund and the Old-Age and Survivors Fund. The Old Age, Survivors and Disability Insurance Program is referred to as OASDI; when you hear a projection that the Social Security trust funds will be exhausted in 2034, that refers to the combined OASDI funds. From time to time, Congress authorizes small reallocations between the funds when one or the other faces a near-term shortfall—most recently in 2015.

Not easy to get. In order to qualify, your client must have worked at least 25 percent of her adult life (and five of the past 10 years); suffer from a severe physical or mental impairment that is expected to last 12 months or result in death; and be unable to perform “substantial gainful activity.”

Only 40 percent of applications are approved after all levels of appeals have been exhausted—a number that has been falling in recent years. What’s more, the program suffers from a severe backlog in applications and appeals. People filing initial applications wait an average of 240 days to find out if they qualify to receive benefits. People who receive determinations on appeal have been waiting an average of 627 days.

Other insurance. An SSDI award makes your client eligible for Medicare following a 24-month waiting period. In many states, it also helps people access Medicaid, which can help pay for nursing or home-based care.

“The health insurance coverage is really important,” says Lisa Ekman, director of government affairs for the National Organization of Social Security Claimants’ Representatives, a group of attorneys that handles disability cases. “Once you get a disability insurance determination from Social Security, it also can help you gain access to Medicaid in many states. Medicare doesn’t cover long-term care, so if a client has a need for institutional or home-based care, the Medicaid coverage is critical.”

If your client has commercial disability insurance through an employer, or has purchased disability insurance directly, the policy probably requires her to apply for SSDI. And many of these policies reduce their benefits dollar-for-dollar for those who are awarded SSDI. However, some commercial policies also set a nominal minimum payout amount; payouts may also depend on the total rate of earnings being replaced by the private policy and SSDI—generally 60 percent of wages.

Most important for older workers. Disability benefits can serve as a sort of early retirement benefit for those who no longer can work. Last year, 70 percent of disability beneficiaries were older than 50, and 35 were older than 60, according to the Social Security actuaries.

Benefit formula similar to retirement. SSDI benefit amounts are calculated using the same formula that determines retirement benefits. It is based on your client’s lifetime average earnings covered by Social Security; if she becomes disabled before qualifying for retirement benefits (age 62), she’ll receive the full benefit earned up to that point.

At full retirement age, the benefit continues under the retirement program. But the SSDI benefit formula differs in one important respect.

The formula for determining benefits starts with a calculation of average indexed monthly earnings. The formula takes any years of earnings that you had before you reached age 60 and indexes them for wage inflation. For a retirement benefit, the highest 35 years of wages are indexed—even if some of those are years of zero earnings. That can reduce average indexed monthly earnings.

In the case of an SSDI benefit, the SSA removes up to five of a disabled worker’s elapsed years with the lowest earnings in calculating her average indexed monthly earnings. This feature reduces the effect of years of lower—or zero—earnings on benefits. That boosts benefits somewhat; the intent here is to recognize that disabled workers have lost years of valuable work credits that cut into their benefits. The average disabled worker benefit is $1,171, compared with $1,360 for retired workers, according to the SSA.

The difference between an SSDI and retirement benefit narrows as your gets closer to retirement age. The amount she would receive is spelled out in the Social Security statement available on the Social Security website.

“For most people, people are buying an insurance policy with their payroll tax contributions,” Ekman says. “It doesn’t matter if they need to stop working due to retirement or a disability. And for older workers, what happens to you in those years leading up to retirement really affects your economic security down the road.”

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