In this article, I discuss the common problems you will face when receiving both CPP disability and long-term disability (LTD) insurance payments. If you have received LTD payments for over a year, your insurer will require you to apply for CPP disability.
This seems like a no-brainer at first — until you realize that if you win CPP disability benefits, your insurance company basically gets to keep all the money. And on top of that, they also get to keep your CPP disability retroactive payment; your overall monthly income may go down slightly, and you might get an unexpected tax bill for the retroactive payment, even though you paid this over to the insurance company.
After learning all this, you are right to wonder: Why in the world would I apply for CPP disability benefits just to save the insurance company money and create all these other hassles for myself?
This is a very good question.
Even with the potential problems listed above, there are still far more advantages of getting CPP disability benefits. Below I review how CPP disability payments interact with your long-term disability insurance payments. I overview two challenges you will face and conclude by discussing the six reasons why applying for (and winning) CPP disability is the smart thing to do.
Interaction of CPP Disability and Long-Term Disability Insurance Benefits
In my experience, most people don’t understand how disability insurance policies work. This leads to a lot of finger-pointing and a general feeling that insurance companies are all evil (they’re not). It is important to understand how insurance policies work, so you can appreciate why your insurance company gets to reduce what it pays you – dollar-for-dollar – based on what you get from CPP disability.
The first thing to understand about disability insurance policies is that you get what you pay for. It’s very much like buying a car — you can buy a piece of junk from the scrap yard, or you can get a BMW. It just depends on how much you or your employer want to spend. The better the policy you buy, the more you pay for it in monthly premiums.
The problem is that most people have disability insurance policies through their work. Meaning the employer purchased it. If your employer wants to save money and buys a cheaper policy, you can be sure it will have clauses that are not great for you.
For example, a common clause that angers people gives insurers the right to deduct CPP disability payments. Theoretically, you or your employer could buy a policy that didn’t include the CPP deduction, but it would cost more. Almost all long-term disability insurance policies allow for a CPP deduction because this clause results in lower monthly premiums. Even my disability insurance policy allows for a CPP deduction, and I chose it because it is much less expensive.
How CPP deductions work
So when your disability insurance policy allows for a CPP deduction, here is now how it works.
Let’s assume you are getting $1,500 per month in disability benefits. And you are approved for CPP disability for a monthly benefit of $500 per month.
This is what happens:
You get to keep the $500 per month from CPP disability. However, the insurance company will reduce your monthly benefit to $1,000 per month. Thus, your total monthly income is the same. You still receive $1500 — you just get two payments now instead of one.
Can the Insurance Company Force Me to Apply For CPP?
LTD insurers cannot directly force you to apply for CPP disability. However, they can indirectly force you by reducing your benefit by the amount you would have received from CPP disability. This is because most LTD policies have a clause that allows the insurance company to estimate and deduct what you should be getting from CPP disability — even though you aren’t getting the benefit. So, the insurance company can say if you had applied and got approved, you would be getting $900 a month, so going forward, we will take $900 off your monthly LTD benefit.
When will they start estimating and deducting?
Insurance companies usually won’t do this right away. They will usually ask you to apply one or more times, and if you continue to refuse, they will start estimating and deducting what you would have been getting from CPP disability. In most cases, insurance companies will hold off on deducting this amount if you have already agreed to apply and signed paperwork that says if you get approved for CPP disability, Service Canada will automatically send your monthly benefits to the insurance company. So, as long as you make a good-faith effort to apply and have signed the paperwork, you shouldn’t worry about these deductions.
Overall, the insurance company can never force you to apply for CPP disability, but they can put alot of pressure on you if you don’t (i.e., reducing your monthly LTD benefit). Ultimately the decision is up to you. You can always refuse to apply if you are fine with having your monthly benefit reduced. However, as you will find out, there are actually alot of benefits to getting approved for CPP disability. So it might be worth your while to apply. But before we dive into that, let’s go over some issues you may encounter when getting approved for CPP disability.
Common Problems When Getting Both CPP Disability and Insurance Payments
The following are the common issues we’ve identified with getting both long-term disability and CPP disability benefits.
1. Winning CPP disability payments may cause your overall monthly income to go down
While your total monthly income will always remain the same once CPP disability is approved, your take-home income can go down if you have a situation where your disability insurance payment is not taxable as income. CPP disability benefits are always taxable as income. So, using the above example, you could go from $1,500 tax-free income to having $1,000 in tax-free income and $500 in taxable income.
Remember that even though part of your income may now be taxable, you still may not owe income tax because your income may be below the level required to be taxed.
2. The retroactive lump sum payment from CPP disability may cause an unexpected tax bill
If you win CPP disability benefits, you will get a one-time retroactive lump sum payment and ongoing monthly CPP payments. For example, it is common for people to get CPP retroactive payments of $10,000 to $20,000. This retroactive payment is taxable income. If the full amount is applied to your taxes on the year you get it, you may have a tax bill.
Even worse, you will owe most (if not all) of the retroactive payment to the insurance company. So, you could have no money to pay the taxes owed! This doesn’t happen often but can happen if you have other income sources or a large retroactive payment for past CPP disability benefits.
Read on below to see how you can avoid this tax problem.
So should you avoid these problems by simply not applying for CPP disability? That would be a BIG MISTAKE for you. Here is why…
Six Reasons You Should Apply For CPP Disability Benefits When on LTD
The following are six reasons why you should apply for CPP disability while on long-term disability.
1. Winning CPP disability increases the odds you will keep getting insurance benefits
Many people are approved for disability insurance benefits, only to have their LTD benefits terminated within two years. There is a good chance your insurer will stop payment of your benefits, even if you are legitimately disabled.
However, getting approved for CPP makes it harder for your insurer to claim you can work. Also, as discussed above, a CPP disability approval reduces the insurance company’s financial obligation to you. Both of these factors weigh in favour of the insurance company continuing to pay your monthly benefits
2. CPP disability is your safety net
Insurance companies are sometimes like deadbeat dads: you can’t depend on them. You never know when the next cheque won’t get sent. While it is hard to get approved for CPP disability benefits, once you are approved, the CPP Disability program is not as ruthless as insurance companies in terminating payment of benefits for deserving people.
If your insurance company suddenly stops payment of disability benefits, then you will continue to receive monthly CPP disability benefits. This gives you some income while you bring a lawsuit against the insurance company for wrongful denial of disability benefits.
3. The insurance company will reduce your monthly benefits either way
This is why you really don’t have a choice. Most disability insurance policies give insurers the power to reduce your monthly disability benefit if you don’t make a good-faith effort to get approved for CPP disability benefits. The insurer will simply estimate the amount of CPP disability benefits “you should have received” if you had made an effort to get approved.
Using the example above, the insurance company would still reduce its monthly payment from $1,500 to $1,000, even though you are not actually receiving the $500 per month from CPP Disability.
This is a trap you need to avoid.
4. Getting approved for CPP disability benefits may result in a higher CPP retirement pension down the road
This is a major benefit for you. Winning CPP disability payments can actually result in you getting a higher CPP Retirement pension when you turn 65.
This happens because you don’t get a penalty for non-contribution to the CPP program while receiving CPP disability. If you don’t apply for CPP disability, you will get assessed as zero contribution for each year going forward. This can often cause you to receive a lower retirement CPP payment than if you had been approved for CPP disability.
5. You get to keep the CPP inflation increases
Each year your CPP disability payment increases according to inflation. Despite this, most disability insurance policies continue to only deduct your original CPP payment amount. Therefore, the result is that you get to keep the CPP inflation increases. And the insurance company won’t get to claw these increases back.
6. There are ways to reduce or eliminate the unexpected tax bill for the retroactive CPP Payment
I am not an accountant and can’t give tax advice. What I can do, however, is to let you know that there are ways to reduce or eliminate an unexpected tax bill caused by a CPP disability retroactive lump sum payment.
First, you can ask Revenue Canada to split the retroactive payment over the tax years it would have been received. This means your $18,000 lump sum payment could be taxed as $9,000 in 2014 and $9,000 in 2015 rather than $18,000 in 2015.
Second, if you paid taxes on your past disability insurance payments, then Revenue Canada will credit this toward the tax on the lump sum payment. In essence, you have already pre-paid the tax on this lump sum payment, so nothing more is owed. This is a common area of confusion between insurance companies, the CPP Administration and Revenue Canada. It can take some doing, but you can’t be taxed twice for the same money. So usually, you can get this fixed. However, if you do nothing, then Revenue Canada may unknowingly tax you twice if you don’t pick up on it, and they don’t notice it.
Third, you can apply for the disability tax credit. If you win this tax credit, there is a good chance it will fully eliminate any tax owing and then some.
Work with a tax professional or accountant to get this sorted out. Every situation is different, so you need to seek personalized tax advice.
Conclusion
At first glance, it seems like getting CPP disability only benefits the insurance company. However, there are actually very compelling reasons for you to try and get approved for CPP disability benefits, even though the insurance company will get to keep all of the money. Winning CPP disability benefits can give you financial security and result in a higher CPP retirement payment. Insurance companies usually don’t claw back the annual CPP payment increases for inflation. So that will be extra money for you going forward.
While you may freak out after getting an unexpected tax bill in the mail (related to the CPP disability lump-sum retroactive payment), usually, when the dust settles, you will not own much, if anything, for taxes. With proper tax planning, you can reduce or eliminate the tax bill by working with Revenue Canada to make sure you get all credits for any taxes paid on past disability insurance benefits or to spread the taxable income over more than one year.
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