If you're receiving long-term disability (LTD) insurance benefits under a group or individual LTD plan, your LTD insurance carrier will likely require you to file for Social Security disability benefits. That's because most LTD policies allow the insurance company to reduce your LTD payments dollar-for-dollar by the amount you receive from Social Security. For example, when a person who receives $1,500 in LTD benefits per month is approved for $1,000 in Social Security disability, he will still collect a total of $1,500, but with $1,000 coming from Social Security and the remaining $500 from the LTD insurance carrier. The amount by which your LTD payment is reduced is called an offset.
While the Social Security offset strikes many disability claimants as unfair, insurance companies are quick to point out that it helps keep monthly premiums low.
When Social Security Backpay Creates an LTD Overpayment
Social Security disability benefits are rarely approved quickly. Unless your disability claim is one of the few approved at the initial level (after your application), you can expect to wait at least a year (often longer) before you're approved. But because the "clock starts running" on your benefits as soon as you file, most Social Security beneficiaries receive a substantial amount of backpay, or past-due benefits, in the form of a lump sum. (In fact, Social Security can pay you for up to 12 months prior to your application date if you became disabled at least 17 months before that date. For more information, see Nolo's article on disability backpay.)
The offset provision in your LTD policy means that your LTD insurance company may be entitled to most or all of this backpay. The rationale is that the company has overpaid you for those months during which you received the full amounts of LTD and Social Security benefits (in the form of backpay).
The insurance company uses the Notice of Award you receive from Social Security to calculate the overpayment. The overpayment is generally the amount of backpay you received minus attorneys' fees (see below). Be sure to double-check the insurance company's math, because mistakes do happen. (Not surprisingly, errors tend not to favor the disabled person!)
How Insurance Companies Handle Overpayments
Insurance companies typically deal with an overpayment in one of three ways. Most companies require immediate reimbursement of the full overpayment amount as soon as you receive your backpay. Others will agree to reduce your monthly LTD payment until the debt is satisfied. Finally, if you don't pay the overpayment out of your Social Security backpay, insurers occasionally stop paying LTD payments entirely until the overpayment has been repaid, but this option is usually a last resort.
Expect your LTD insurance company to require you to sign a Social Security Reimbursement Agreement, stating that you'll repay any retroactive Social Security benefits to the company. You may also be sent a Payment Option Form offering you the choice to receive a reduced amount of LTD benefits while your Social Security case is pending, so that you don't have an overpayment to pay back with your Social Security backpay. Predictably, almost no one accepts this rather unappealing offer.
How Dependents Benefits and Attorneys' Fees Affect the Offset
If Social Security is paying dependents benefits to your spouse or children based on your disability (often referred to as "auxiliary benefits" in LTD policies), many LTD policies allow the insurance carrier to offset these amounts (subtract them from your LTD payments) as well.
Social Security's yearly cost-of-living adjustment (COLA) is rarely factored into the offset.
Attorneys' fees (typically 25% of your Social Security backpay) are generally not included when figuring the offset, allowing many Social Security disability claimants to obtain essentially free legal representation. (The 25% fee is taken out of your backpay before the insurance company calculates the overpayment.) While your insurer may offer to provide you with an attorney or (more likely) a non-lawyer representative to handle your disability case, it's usually a better idea to hire an experienced, independent disability attorney, especially if you can do so free of charge.
Every policy is unique, so read your policy's summary plan description or contact your insurer to learn how dependents/auxiliary benefits and attorneys' fees can affect the Social Security offset.
Offsets for Other Forms of Income
In addition to deducting Social Security disability benefits, the vast majority of LTD policies offset other forms of income such as state short-term disability benefits, workers' compensation benefits, and third-party settlements (such as a personal injury award). Common sources of income that are not offset include 401(k) plans, individual retirement accounts, severance packages, stock options, and profit-sharing plans.
Occasionally the amount of a recipient's deductible (offset-able) income, whether from Social Security or other sources, actually exceeds the monthly LTD payment. In these instances, rather than paying you nothing, most policies provide for a minimum monthly benefit of $50 or $100 that a person can collect regardless of the offset amount.
Individual Policies vs. Group Policies
Note that individual disability policies (as opposed to employer-provided group plans) are more likely to be tailored to the individual purchaser, rather than fitting the mold of a group plan. While you'll still find many individual plans with a legion of offsets, a first-class individual plan might not provide for any offsets at all, even for Social Security disability. The wide variation among long-term disability policies makes it essential that you read your plan carefully.