A salary continuation plan is an employer-funded arrangement that keeps paying part or all of your regular wages when illness or injury keeps you from working. The money comes out of the company’s own general assets rather than from an insurance carrier, which means your employer bears the full financial risk of every claim and you are, in effect, relying on a corporate promise rather than a regulated insurer. These plans appear most often as an executive perk, though some employers extend them more broadly. The tax rules, ERISA obligations, and insolvency exposure all turn on structural details written into the plan document.
How It Differs from Disability Insurance
The defining feature is that no insurance company sits between you and your paycheck. Your employer writes the checks from its general corporate funds. That changes three things in practice.
The employer controls every part of the claims process internally, from verifying your medical condition to approving payment. There are no premiums flowing to an outside carrier, so the employer’s cost is zero until someone gets sick or hurt. And because the plan is unfunded, there is no segregated pool of money set aside for future claims. Your benefits depend on the company’s ability and willingness to pay when the time comes.
A traditional short-term disability policy works the opposite way. The employer pays premiums to a carrier, the carrier pays claims out of its own reserves and assumes the financial risk, and you have a claim against a regulated insurer rather than a promise from the company treasury.
Who Qualifies
Most salary continuation plans restrict access to a narrow group. Employers commonly limit participation to senior executives, key managers, or other highly compensated employees. Plans built this way are often called “top-hat” plans because they cover a select group of management or highly compensated employees.1U.S. Department of Labor. Top Hat Plan Statement That classification carries real regulatory advantages, which is one reason employers structure the plans this way.
A formal written agreement is required. The plan document spells out who qualifies, what medical conditions trigger benefits, how long you must have worked at the company before you’re eligible, and what “disability” means under the plan. Some plans require one year of continuous service; others set the bar at three or five years. The definition of disability varies too. Some plans pay only if you’re completely unable to perform your job duties, while others cover partial impairment that limits your hours. If the triggering condition isn’t clearly defined, disputes about whether you qualify become much harder to resolve.
What You’d Actually Get Paid
p>Payment structures vary, but a common approach is tiered. A plan might pay 100% of your regular salary for an initial period, then step down to 60% or 70% for a longer stretch to manage the employer’s exposure. The initial full-pay period could last anywhere from 30 to 90 days, with the reduced rate continuing for several months up to two years total.
Nearly all plans include a waiting period before payments begin. You might need to be out of work for anywhere from five days to two weeks before continuation kicks in. Plans also frequently coordinate with your accrued sick leave, meaning you’d burn through paid sick days first and continuation payments would start only after those are exhausted. The plan document specifies a maximum benefit duration. Once that window closes, you’d need to transition to long-term disability coverage, Social Security Disability Insurance, or another income source.
How the Payments Are Taxed
Salary continuation payments are taxable income to you. Under IRC Section 105, amounts you receive through an employer-funded accident or health plan for sickness or injury are included in your gross income to the extent they’re attributable to employer contributions or paid directly by the employer.2Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans IRC Section 106 excludes the employer’s coverage itself from your income, but the actual cash paid on a claim does not get that exclusion.3Office of the Law Revision Counsel. 26 USC 106 – Contributions by Employer to Accident and Health Plans
Your employer withholds federal income tax and reports the payments on your W-2, just like regular wages. Salary continuation payments are also subject to Social Security and Medicare (FICA) taxes and federal unemployment (FUTA) tax, but only for a limited window.
The Six-Month FICA Exemption
Social Security, Medicare, and FUTA taxes stop applying to sick pay once you’ve been absent from work for more than six full calendar months.4Internal Revenue Service. Publication 15 (2026), (Circular E), Employers Tax Guide IRC Section 3121(a)(4) excludes from FICA wages any payment made on account of sickness or disability after six calendar months have passed since the last month you worked.5Office of the Law Revision Counsel. 26 USC 3121 – Definitions
Counting works by calendar months, not days. If your last day of work was in January 2026, the six-month clock runs through July 2026. Any salary continuation paid to you starting in August 2026 would be exempt from FICA and FUTA, though still subject to federal income tax. One catch: if you return to work for even a single day during that period, the clock resets from the month you last worked.6Internal Revenue Service. Employers Supplemental Tax Guide
The Section 409A Trap
This is where salary continuation plans get dangerous if they’re poorly designed. IRC Section 409A imposes strict rules on nonqualified deferred compensation, and a salary continuation plan structured in a way that creates a legally binding right to payment in a future tax year can fall under 409A’s reach.7eCFR. 26 CFR 1.409A-1 – Definitions and Covered Plans The penalties for a 409A violation land on the employee, not the employer.
If a plan fails 409A compliance, all deferred compensation under the plan for the current year and all prior years becomes immediately taxable. On top of regular income tax, you’d owe a 20% additional tax on the compensation that should have been included earlier, plus interest calculated at the underpayment rate plus one percentage point going back to the year the compensation was first deferred.8Office of the Law Revision Counsel. 26 USC 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans
The Treasury regulations carve out a broad exemption for bona fide disability pay. A plan that provides genuine sick leave or disability payments is not treated as nonqualified deferred compensation, so 409A doesn’t apply.7eCFR. 26 CFR 1.409A-1 – Definitions and Covered Plans There’s also a short-term deferral exception: if benefits are paid within two and a half months after the end of the tax year in which the right to payment is no longer subject to a substantial risk of forfeiture, 409A doesn’t apply either.
The plans that run into trouble blend salary continuation with deferred compensation features, such as paying benefits tied to separation from service or deferring payments past the short-term deferral window without meeting 409A’s distribution timing rules. Executive plans are especially exposed because they’re often layered with other deferred compensation arrangements. If your employer offers you a plan with complex payout triggers or timing provisions, raise the 409A question with a tax advisor before you sign.
Your ERISA Rights
Private-sector salary continuation plans are employee welfare benefit plans subject to the Employee Retirement Income Security Act. ERISA’s foundational policy, codified at 29 U.S.C. § 1001, requires disclosure, reporting, and fiduciary standards for these plans.9Office of the Law Revision Counsel. 29 USC 1001 – Congressional Findings and Declaration of Policy
Every covered plan must provide participants with a Summary Plan Description. Under 29 U.S.C. § 1022, the SPD must be written in language the average participant can understand and must include the plan’s eligibility requirements, a description of benefits, the claims procedure, and information about the plan administrator.10Office of the Law Revision Counsel. 29 USC 1022 – Summary Plan Description If you’re covered and haven’t received an SPD, you have the right to request one, and administrators who fail to provide requested plan documents face statutory penalties.
Top-hat plans get a lighter regulatory load. Under 29 CFR § 2520.104-23, the plan administrator satisfies ERISA’s entire reporting and disclosure requirements by filing a one-time statement with the Department of Labor identifying the employer, stating that it maintains a plan for a select group, and reporting the number of employees covered.11eCFR. 29 CFR 2520.104-23 – Alternative Method of Compliance for Employee Pension Benefit Plans for Certain Selected Employees That exempts the plan from annual Form 5500 filings and much of the disclosure machinery that applies to broader plans.1U.S. Department of Labor. Top Hat Plan Statement For plans that don’t qualify as top-hat, the full ERISA reporting regime applies.
What Happens If the Employer Goes Under
This is the fundamental risk of an unfunded plan, and it rarely gets discussed during enrollment. Because salary continuation payments come from general assets, you’re an unsecured creditor if the employer becomes insolvent. There’s no insurance fund backing these promises, no PBGC-style safety net, and no segregated account with your name on it.
In bankruptcy, your claim for unpaid salary continuation benefits falls into the priority system under 11 U.S.C. § 507. Wages, salaries, and sick leave pay earned within 180 days before the bankruptcy filing receive fourth-priority status, but only up to $17,150 per individual.12Office of the Law Revision Counsel. 11 USC 507 – Priorities Employee benefit plan contributions get fifth priority, and the combined cap for both categories is also $17,150 per employee. Anything above that threshold becomes a general unsecured claim, paid only after priority creditors are satisfied and typically at pennies on the dollar.
Some employers use a rabbi trust to set money aside informally. A rabbi trust is irrevocable, which gives you some protection against an employer that later changes its mind about paying. But the assets remain available to the employer’s creditors in insolvency. The trust protects you against a reluctant employer, not a broke one. If insolvency risk concerns you, ask whether any informal funding mechanism is in place and understand exactly what it does and doesn’t cover.
Coordination with Other Benefits
Salary continuation plans don’t operate in isolation. Most plan documents include offset provisions that reduce your benefit if you’re receiving income from other sources during the same disability. The most common offsets involve workers’ compensation payments, Social Security Disability Insurance, and state-mandated paid leave programs.
On the Social Security side, there’s an asymmetry worth knowing. The Social Security Administration’s own offset rules reduce SSDI when you’re also receiving workers’ compensation, but they specifically exclude private insurance and private pension benefits from the offset calculation.13Social Security Administration. Workers Compensation, Social Security Disability Insurance, and the Offset A Fact Sheet So Social Security won’t cut your SSDI because of salary continuation payments. The offset can run the other way, though: your salary continuation plan may reduce its payments dollar-for-dollar once you start collecting SSDI. Check the plan document for the specific offset language.
A growing number of states operate paid family and medical leave programs with their own benefit schedules. If you’re in one of those states, your salary continuation plan may coordinate with those payments as well. The interplay depends on the plan document’s offset provisions and the state program’s rules about employer-provided benefits.