Why you should ALWAYS apply for CPP disability benefits.

If you have been receiving long-term disability (“LTD”) benefits for over a year your insurance company will likely require you to apply for Canada Pension Plan (“CPP”) disability benefits. This seems like a no-brainer at first, until you realize that if you win CPP disability your insurance company basically gets to keep all the money. You will have to give the insurance company the retroactive payment you get from the CPP, 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.

So 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 several advantages to you in winning CPP disability benefits. Below I review how CPP payments interact with your LTD benefits, I review two big problems 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 LTD insurance benefits.

Most people don’t really understand how LTD 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 LTD 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 LTD 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 go get a Cadillac. It just depends on how much you, or your employer want to spend in premiums. The better the policy you buy, the more you pay for it in monthly premiums.

The problem is that most people have LTD insurance policies through their work, so they are actually bought by the employer. If your employer wants to save money and buys a cheaper LTD policy, you can be sure it will have clauses that are not great for you.

For example, a common clause that angers people is the one that gives insurance companies 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. So almost all LTD insurance policies allow for a CPP deduction because this clause results in lower monthly premiums.

So when your disability insurance policy allows for a CPP deduction here is now how it works:

  • assume you are getting $1,500 per month in disability benefits;
  • you are are approved for CPP disability benefits of $500 per month.

This is what happens:

  • You get to keep the $500 per month from CPP disability, but your monthly LTD benefit is reduced to $1,000 per month.
  • Your total monthly income is unchanged (i.e., $1,500), you just get two checks now instead of one.

Common problems when getting both CPP disability and LTD insurance benefits.

It is important to be aware of the potential problems or headaches you will face if you get approved for CPP disability benefits, while you are also receiving LTD insurance payments.

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 you disability insurance payment was 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.

Keep in mind 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 may cause an unexpected tax bill.

If you win CPP disability benefits, you will get a one-time retroactive lump sum payment in addition to ongoing monthly CPP disability 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, it is possible you will have a tax bill.

Even worse, you will owe most if not all of the retroactive payment to the insurance company, so this can leave you with no money to pay the taxes owing! This doesn’t happen often, but can happen if you have other sources of income, or if you have a large retroactive payment for past CPP disability benefits.

Six reasons you should apply for CPP disability benefits even if you are already getting LTD insurance benefits.

1.Winning CPP disability increases the odds you will keep getting LTD insurance benefits.

Many people are approved for LTD insurance benefits, only to have the insurance company terminate payment of benefits after two years. There is a very good chance your insurance company will stop payment of your disability benefits, even if you are honest and legitimately disabled.

There is no doubt that being found totally disabled by the CPP disability program makes it harder for your insurance company to say 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 if you continue to be unable to work in any employment.

2. CPP disability is your safety net.

Insurance companies are sometimes like a dead-beat dad: you can’t depend on them. You never know when the next cheque is going to not 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 private insurance companies in terminating payment of benefits for deserving people.

If your insurance company suddenly stops payment of LTD 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. Your monthly LTD insurance benefits get reduced either way.

This is why you really don’t have a choice. Most disability insurance policies give insurance companies 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 insurance company will simply estimate the amount of CPP disability benefits “you should have received” if you had made a good faith effort to get approved.

Using the example above, the insurance company would still reduce it’s 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 you are receiving CPP disability. If you don’t apply for CPP disability, you will get assessed as making a zero contribution for each year going forward and this can often cause you to receive a lower CPP retirement payment than if you had been approved for CPP disability benefits.

5. You get to keep the CPP inflation increases.

Each year your CPP disability payment will be increased according to inflation, however most disability insurance policies continue to deduct only your original CPP payment amount. Therefore, the result is that you get to keep the CPP inflation increases. These increase are not clawed back by the insurance company.

6. There are ways to reduce or eliminate the unexpected tax bill for the retroactive CPP Payment.

Although I am not an accountant and cannot give tax advice, I can tell you that there are ways you can 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 2015 and $9,000 in 2016, rather than $18,000 all in 2016.

Second, if you paid taxes on your past LTD insurance payments, Revenue Canada will credit this toward the tax on the lump sum CPP 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.

Work with a tax professional or accountant to get this sorted out. Every situation is different so you need to seek your own personalized tax advice.

Conclusion.

While it may seem that winning CPP disability benefits only benefits the insurance company, there are actually very compelling reasons for you to try and get approved for CPP disability benefits, even thought the insurance company will get to keep all of the money. Winning CPP disability can give you financial security and result in a higher CPP retirement payment. The 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 receive an unexpected tax bill in the mail (related to the CPP disability lump-sum retroactive payment), usually 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 LTD insurance benefits or to spread the taxable income over more than one year.