Key Disability Insurance Concepts

Income is the key to a strong financial plan and this is how disability insurance policies work to protect it.

What is the most important thing for you to insure?

When we think about insurance, often security and protection come to mind. We think about our vehicles, our home, or even our health. That’s smart because those are expensive to replace– but we often overlook our greatest asset– our income.

Depending on your age, over the course of your working career, you could earn millions in income so it’s smart to protect it. There are two forms of insurance that do this – short-term disability insurance and/or long-term disability insurance.

What is Disability insurance?

Disability insurance is insurance that provides a monthly payment if your disability makes you unable to work. A disability could be any physical or mental impairment that holds you back from a normal life or work or daily living. This is different than workers compensation, where you only have protection if an injury happens at work. Disability insurance protects your income even if the injury or illness happens in your normal life. `

There are two main forms of disability insurance:

Short-Term Disability Insurance

Short-term disability insurance typically provides coverage for disabilities that are acute or temporary and last shorter than 3 months.

When is it right for me?

Short term disability insurance is usually a great option for anyone who doesn’t have an emergency fund or is worried about missing even one paycheck. Also, it can be a great fit for women who are considering becoming mothers. Short-term disability can sometimes add additional paid time off for maternity leave.

If you have a large emergency fund or passive income or don’t plan on a pregnancy, you can sometimes forgo short-term disability insurance.

How does it work?

All short-term disability policies will have a defined waiting, or elimination, period, ranging from 7-60 days. Once an event happens, the waiting period is the length of time before the benefit kicks in.

Your benefit amount will vary depending on your policy but typically pays 60% of your gross income, can be turned on and off in tandem with your PTO, and will not pay more than your usual weekly wage.

Here is a great example: Jamie is a 35-year-old mother to be. She has 2 weeks of paid time off (PTO), and 2 weeks of sick leave. She has also purchased a short-term disability policy with a 7-day waiting period. Jamie’s due date is in 30 days, but her doctors are concerned and decide to place Jamie on bedrest. Jamie, knowing her disability will last longer than 7 days, submits a claim. Jamie will be paid 60% of her pay for 90 days after her waiting period.

During that period, Jamie can choose to use some of her sick pay or PTO to increase her income to 100%. Jamie has been saving well and instead decides to wait until the end of her disability period to use her PTO and extend her time with her new baby. Family Medical Leave Act guarantees her protection from losing her job for up to 12 weeks and she uses her PTO and sick leave for the other 4.

Because Jamie purchased short-term disability insurance and used her PTO and sick leave, she was able to be out of work for 4 months, spend 3 months after delivery, and keep 70% of her income during the whole period.

Without short-term disability insurance, Jamie would have had only 4 weeks of pay available, and could have felt an extreme pressure to return to work and begin earning again.

Long Term Disability Insurance

Long-term disability typically provides coverage for disabilities that last longer than 3 months and will pay up until retirement age.

When is it right for me?

Honestly, it’s probably a smart idea to have for most people. One in four 20-year old’s will experience a disability that will leave them out of work for at least one year.

You may not need it when you are close to the end of your career or already have significant passive income not tied to your work but if you still need your income for your lifestyle or goals, this is a smart thing to have in pace.

How does it work?

Like STDI, LTD insurance starts paying after a specified waiting period, generally 90-180 days. Most LTD insurance has a benefit payout of 50% and can be as high as 80%, but you can’t get more coverage than you actually make.

What does a disability policy cost?

Prices for both short- and long-term disability policies can vary greatly depending on age, gender, occupation, health, waiting period, riders, and the benefit amount. Typically, the cost per year is 1 – 3% of your annual salary.

What’s the best way for me to get a disability plan?

Your employer is the first place to look for coverage because they will often pay for some of your policy. If you aren’t sure you have it, ask your HR and make sure you’re ready during your yearly open enrollment period to elect into it. Make sure you understand the waiting period, benefit amount, and best way to submit a claim.

If your employer only offers 50% or none at all, you can get a policy with a trusted advisor, agent or online brokerage to fill the gap. Be sure you get coverage with a quality carrier and you understand exactly what qualifies as disability.

What else should I think about?

Riders:

Generally, all insurance policies have riders or options. Most policies include riders for free but some will only be available for an additional premium.

Common included riders:

• Guaranteed renewable – your policy will stay in effect as long as premiums are paid
• Non-cancellable – the insurance provider cannot cancel your policy or change your premiums
• Presumptive total disability – if you lose your hearing, speech, sight, or two limbs your elimination period will be waived, and you will immediately start receiving benefits
• Waiver of premium – once your claim has been accepted you will not have to pay your premiums until your benefit period has ended or you are no longer disabled
• Automatic increase – you are pre-approved to increase your amount of coverage without having additional health screening for the first 3-5 years of the policy
• Rehabilitation benefit – the policy will pay an additional amount to support your rehabilitation and training for a new job
• Survivor benefit – this rider will pay a lump sump worth a few months of your benefit to your beneficiary if the disability leads to your death

Riders you pay extra for:

• Cost-of-living adjustment – this provides a yearly adjustment to your benefit to keep pace with inflation. Since a disability can happen anytime during your lifetime, it usually makes the most sense to have this rider and protect your purchasing power when you are young.
• Own Occupation – Depending on your policy this may already be included and for specialty jobs can be really important. This protects your income should you no longer be able to accomplish your specific occupation. For example, if you are a surgeon who becomes disabled from your own occupation with a tremor, this rider would allow you to receive the full benefit even if you are making new income as a teacher.
• Partial or residual disability – Perhaps your disability allows you to keep your job, but you need to reduce your hours. This rider allows you to be paid for the difference in your income due to the lost productivity.

Social Security will take care of most of this, right?

Unfortunately, Social Security is rarely the correct solution for most people because social security only supports the disability definition of any occupation. If you can perform any job in the US, then you will not qualify for Social Security benefits. Even if you are approved, the average decision amount for a Social Security disability benefit is $15,348 yearly, which is below the poverty line in America.

How does tax work?

As a rule, if someone else pays for the plan (like your employer) then you will pay income tax on the benefit when it pays out. Alternatively, if you paid for the plan (and didn’t deduct it) then you would receive the benefit tax free. As you think about your needed benefit, keep tax considerations in mind.

In Summary

Income is the keystone to a strong financial plan, which makes disability insurance crucial to have. It’s hard to imagine yourself hurt or sick but even a year or two out of work can be devastating to your financial goals. Fortunately, it can be easy to obtain through your job or is often inexpensive if you need to purchase it yourself.

Disclaimer: This post is for informational purposes only and is never to be taken as advice or a recommendation. Talk to a tax or legal professional to determine how this information best applies to your personal situation.