What Is Residual Disability and How Does It Affect Benefits?

Residual disability is a concept for individuals experiencing a reduced ability to work due to illness or injury. It differs from a complete inability to work by acknowledging that some work capacity remains, though it is diminished.

Understanding Residual Disability

Residual disability describes a situation where an individual can still perform some work, but their capacity to earn income is significantly reduced because of an illness or injury. This contrasts with “total disability,” where an individual is completely unable to perform the duties of their occupation or any occupation. Residual disability recognizes a partial rather than a complete loss of earning capacity.

This type of disability acknowledges that a person might work fewer hours, perform fewer duties, or switch to a lower-paying role due to their health condition. For instance, a person might work part-time or in a less physically demanding role after an injury, but their earnings would be less than before the disability.

Residual disability aims to provide financial support, preventing a complete loss of income while encouraging a partial return to work. Many disability insurance policies include provisions for residual disability, either as a standard feature or an optional rider.

Measuring Impairment

Determining the extent of residual disability involves assessing the impact of an illness or injury on an individual’s ability to work and earn income. Medical evaluations are a primary component, providing documentation of the health condition and its limitations. These evaluations establish the medical basis for the impairment.

Functional capacity assessments are used to objectively measure an individual’s physical and cognitive abilities related to work tasks. These assessments involve tests and observations to evaluate physical strength, endurance, flexibility, and other relevant capacities. This helps quantify how the disability restricts job duties.

The impact on pre-disability earnings is another significant factor in measuring residual impairment. Pre-disability earnings refer to the income a policyholder earned before the disability began, calculated as an average over a specific period. Insurance companies compare current earnings to these pre-disability earnings to determine the percentage of income loss. Most policies require a minimum income loss, often ranging from 15% to 20%, to qualify for residual benefits.

Implications for Disability Benefits

Residual disability directly impacts how benefits are calculated and paid under disability insurance policies. Insurance companies calculate residual benefits based on the percentage of income lost due to the disability. For example, if an individual’s income is reduced by 40% due to disability, their benefit might be 40% of the amount they would have received for a total disability.

Some policies may pay the full total disability benefit for an initial period before adjusting to a percentage based on lost income. There can also be minimum income loss thresholds, commonly 15% to 20%, to trigger residual benefits, and a maximum loss, such as 75% to 80%, beyond which total disability benefits might apply.

Disability benefit payments, including residual benefits, have tax implications depending on how the insurance premiums were paid. If an individual paid the premiums for their disability insurance policy with after-tax dollars, the benefits received are generally not taxable. However, if an employer paid the premiums, or with pre-tax dollars, the benefits become taxable income. If both the employer and employee contributed to the premiums, the taxability of the benefits is prorated based on each party’s contribution.

Disability policies include provisions for coordinating benefits with other income sources, which can affect the final payout. For instance, long-term disability policies may reduce benefits if the individual receives income from other sources like Social Security Disability benefits or workers’ compensation. These policies have a minimum benefit provision, ensuring a small payment even if offsets significantly reduce the calculated amount.