Q: How Does Disability Insurance Work?

What happens if your employee gets sick or injured and can’t come into work? Long-term and short-term disability insurance is what can help that employee pay the bills while they’re recovering from such a difficult ordeal. 

Gusto makes payroll, benefits, and HR actually easy.

In most states, there are no laws that say employers have to provide disability insurance. But offering it can give you a competitive edge and help you attract and retain talented employees

Short-term and long-term disability insurance plans are offered by a variety of states and private companies. So the specifics of each insurance plan really vary, depending on which one you select. 

But how does disability insurance actually work? And what’s the difference between short-term and long-term disability insurance plans? Here are the basics you need to know as an employer. 

Do I have to offer disability insurance to my employees?

Do you live in…

California, Hawaii, New Jersey, New York, Rhode Island or Puerto Rico?Yes, you have to offer some type of disability insurance
Any other state?No, you do not have to offer short- or long-term disability insurance

Even if you don’t have to offer long- or short-term disability insurance, these programs may still be a good idea. About one in four 20-year-olds will miss at least a year of work before they retire due to a disability, and 5.6 percent of Americans experience a short-term disability every year, according to the Council for Disability Awareness. 

If you don’t offer disability insurance as an employee benefit, your team can still purchase individual short-term or long-term disability insurance on their own. 

Now, let’s dig into what each type of disability insurance means.

What is short-term disability insurance?

Short-term disability insurance (STDI) is typically the next option an employee has after they use up all of their paid time off (PTO).

(You can allow your employee to use their STDI before draining their sick leave bank, but that policy decision is up to you. It just has to be the same rule for all your employees.) 

On short-term disability, your employee won’t receive their full salary. Most plans cover between 60 and 80 percent of their regular pay, and there may be a weekly pay cap. 

How long does short-term disability insurance last? The exact length of time these policies cover depends on your plan. One may only pay out benefits for a few weeks, and another may help your employee out for up to a year. Some plans may require a “waiting period,” which is also called “an elimination period.” This is the time between when an employee enrolls in the plan and when they can receive benefits. That’s often around two weeks. 

STDI can be used for a number of illnesses and injuries, but pregnancy (or complications after pregnancy) is one of the most common reasons. Other reasons include: 

  • Musculoskeletal problems
  • Digestive disorders
  • Joint disorders
  • Short-term illnesses

What is long-term disability insurance? 

Long-term disability insurance (LTDI) can be used by employees who have exhausted their short-term disability insurance or are diagnosed with a chronic illness. These plans typically cover about 60 percent of an employee’s salary, but last for a significantly longer time—sometimes until retirement age. 

Just like STDI, long-term plans often include a per-month maximum, which may be up to $10,000 a month, depending on your plan.

With LTDI, your employees will probably have to wait longer after signing up for a plan. Expect a waiting period of about 90 days, although that could be different depending on your insurance company. Insurance claims may take a few months to process as well. 

Common reasons for LTDI include:

  • Arthritis
  • Back pain
  • Cancer and other chronic illnesses
  • Mental illness, like depression
  • Diabetes

How are long- and short-term disability insurance different?

 Let’s break it down.


Long-term disabilityShort-term disability
How long it lastsA few months to the rest of someone’s lifeA few weeks to a year
What it coversChronic illnesses and debilitating injuriesShort-term illnesses, injuries, or conditions (like pregnancy)
Percent of salary received by an employeeAbout 60%About 60–80%
Waiting periodAbout 90 daysAbout two weeks

How much does disability insurance cost?

On average, short- and long-term insurance plans usually cost $0.15 per employee, per hour worked—or, typically, about 1% of their total compensation cost, according to the Bureau of Labor Statistics. To offset costs, some business owners prefer to have their employees contribute a percentage of the plan total. 

When shopping for insurance companies, it’s important to choose a plan that balances benefits and costs in a way that makes the most sense for your business. 

What do I do if an employee files a disability claim?

If your business offers disability insurance, you should get familiar with the Employee Retirement Income Security Act, or ERISA. (If you’re a government entity or religious organization, ERISA doesn’t apply.) 

This federal act dictates how claims are made and what standards disability plans must meet. While most of the rules apply to insurance companies, not employers, it’s a good idea to understand ERISA anyway. 

How the employee claim process works

Your employee will file a claim directly with their insurance company, who will have 45 days to make a decision, although they can ask for a 30-day extension. 

During the waiting period, your employee may elect to continue working or use their STDI (if their insurance company approves their claim), sick leave, vacation or—with your approval—unpaid leave.

During the first 12 weeks of your employee’s absence, they are covered by the Family and Medical Leave Act (FMLA) as long as the following conditions apply:

  • Your business is a public agency, or you employ 50 or more employees for at least 20 weeks each year. And at least 50 of those employees need to be located within 75 miles of the worksite of the employee filing the claim.
  • Your employee has worked at least 1,250 hours during 12 months before taking leave and has worked for your business for at least 12 months in total. (No, the 12 months don’t have to be consecutive, but they generally must have taken place within a seven-year window.)

The FMLA doesn’t require you to pay your employee, but it does require you to maintain your employee’s benefits and hold their job (or an equivalent position) until the 12 weeks are up. After the FMLA period ends, you’re allowed to terminate your employee if they decide not to return to work. 

What should my employees expect if I offer disability insurance?

ERISA has several requirements for employers:

  • You must provide a summary plan description to your employees, which is a document that explains the benefits the plan covers, how the plan works, and how your team can file a claim.
  • If you have 100 or more plan participants, you must file Form 5500 with the IRS each year and provide an annual report that summarizes the information in Form 5500 to your employees.

Are disability payments taxable? 

Whether or not disability payments are taxable is a complicated subject, and you may want to advise your employees to speak with an accountant about their unique situations. 

Generally, only the portion of disability payments paid for by you, the employer, is taxable. That means if you paid the entire premium, your employees’ payments are taxable. However, if you and your employee split the cost of the plan’s premiums, the payments may be only partially taxable.

For instance, if you and your employee both pay $50 per month for their plan—for a total of $100—they will only have to pay income tax on 50% of their disability payments. And if the disability insurance was paid for via a pre-tax cafeteria plan, that amount will be taxable.

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