For employers considering short or long term disability plans there are a great many decisions to be made about plan design, funding and administration. Should benefits be insured, should employees contribute to the cost of benefits, and, if the employer is going to self-insure benefits, how will these be funded and administered?
When making these decisions, employers should know these decisions don’t just affect the employer or the disability plan itself. Each of these decisions may have specific employee impacts, in areas such source deductions, employee eligibility for EI and CPP retirement benefits and employee RRSP contributions.
The most fundamental decision employers have to make is whether the plan will qualify as an income tax Wage Loss Replacement Plan (WLRP). For example, the employer may decide simply to provide salary continuance during any claim for short-term disability. Alternatively, the employer may provide disability benefits through an Administrative Services Only (ASO) arrangement, under which there are no contributions to a fund per se, but the employer simply reimburses the 3rd party ASO for any disability benefits paid. Neither of these would qualify as a WLRP (see IT-428), so any benefits paid would be regular employment income and gross benefits would be subject to all normal source deductions.
Alternatively, the plan might qualify as a WLRP, but provide lump-sum, instead of periodic (usually monthly) benefits. The principal impact is on the timing of any taxable benefit from employer contributions to the plan. Where a WLRP provides for the payment of lump-sum benefits, employer contributions to the plan are the taxable benefit. As a consequence, lump-sum benefits themselves are free from all source deduction. By contrast, where benefits are periodic, the source deduction requirements are focused on benefit payments.
This distinction between the right to periodic versus lump-sum WLRP benefits only matters where employees contribute to the plan. Plans may be structured so employers cover all costs, the cost of WLRP coverage is split between employers and employees or employees pay all plan costs. Where plan contributions are made only by employees (‘employee pay-all’), no source deductions apply; the same as there are no source deductions on the payment of lump-sum WLRP benefits, since employer contributions are recognized as the taxable benefit.
While receiving WLRP benefits on a tax-free basis maximizes the short-term dollars in employee pockets, there may be some longer term impacts that employers and employees alike should consider. If WLRP benefits are not a taxable benefit, there are no CPP contributions or pensionable earnings while on disability. This may not be a problem for short-term disability, but if an employee remains on long-term disability for an extended period of years, tax-free WLRP benefits may mean a significant reduction in the CPP retirement pension eventually paid.
This is only a problem where employees do not also qualify for CPP disability benefits. When you qualify for these, your CPP retirement pension is based on months other than those for which CPP/QPP disability benefits were payable. If, however, a person is on WLRP benefits, but does not qualify for CPP disability benefits, CPP retirement benefits are effectively reduced for every month the person has no pensionable earnings while in receipt of tax-free WLRP benefits.
There is a similar issue with RRSP contributions. If a person is on tax-free WLRP benefits, these are not earned income for the purposes of creating RRSP contribution room. This limits the RRSP contributions which can be made while on these benefits.
An employee’s potential CPP retirement pension may also be affected by WLRP benefits provided under a contract of insurance. If WLRP benefits are provided by an insurance company acting in its own right, under the terms of an insurance policy for the WLRP, any benefits paid are not CPP pensionable. While such benefits may be taxable, if paid on a periodic basis and partly or wholly employer funded, they are not subject to CPP source deductions. The same as with tax-free WLRP benefits, this means an effective reduction in CPP retirement benefits, unless employees also qualify for CPP disability benefits.
Paying WLRP benefits on a tax-free basis may also impact employee eligibility for EI. If WLRP benefits are not subject to source deduction when paid, there are no related insurable hours. For example, an employee could return to work from short-term disability, only to be laid off for other reasons, and not have the insurable hours required to establish an EI claim.
There are two ways these impacts might be avoided. First, employers should consider savings plan options when employees receive WLRP benefits that are not CPP pensionable. Perhaps long-term disability benefits could be structured so that a portion of these are paid directly into an RRSP, if benefits are income taxable, or into a TFSA, for benefits paid on a tax-free basis. Second, perhaps the government should consider amending the Canada Pension Plan, to eliminate the distinction in CPP treatment for WLRPs, based on whether benefits are paid by the employer or a 3rd party. It’s not clear why this distinction in how WLRPs are structured should affect their treatment for source deduction purposes.
Alan McEwen is a Vancouver Island-based HRIS/Payroll consultant and freelance writer with over 20 years’ experience in all aspects of the industry. He can be reached at email@example.com, (250) 228-5280 or visit www.alanrmcewen.com for more information.