Personal Finance 101 – Do You Really Need Disability Insurance?

By Brittany Mollica

You’ve heard of life insurance and understand why it’s important, but did you know that disability is a much more prevalent risk than early death? According to the Social Security Administration, you are almost four times more likely to be disabled than to die before reaching normal retirement age.1

For most people, dying is a more visceral fear, so we tend to focus our anxiety and worry on the possibility of death. But facing a period of disability without the proper insurance in place is a serious risk. If you lose income because you’re too sick or injured to work, the financial cost to you and your family can be devastating. If a catastrophic event has such high odds, it makes sense to plan for it.

So how do you protect yourself against the loss of income because of disability? It’s not easy – if you could simply save up enough money so you didn’t have to work, you would probably just retire. This is a classic case for insurance – pooling your resources with a bunch of other people to provide for the unlucky ones in the pool. Let’s talk about how disability insurance works.

Before we get into the details, note that disability insurance is different from the following types of insurance:

  • Life insurance – generally, these policies pay your beneficiaries a benefit only when you die
  • Long term care insurance – these policies pay you a benefit to help cover the costs of custodial care due to a physical or mental disability, often for people in nursing homes or assisted living homes
  • Health insurance – these policies help to cover the cost of medical treatment for a wide variety of illnesses, injuries and conditions

Disability insurance, on the other hand, helps replace the income that you would lose if you become sick or injured and can no longer work. You can often get disability insurance through your employer (usually known as Group Insurance) or on your own (Private Insurance). If you already have Group Insurance, you may even supplement it with Private Insurance, if you think you need more coverage.

Almost every policy includes an elimination period, an amount of time you must wait before receiving benefits. It is important to know what your elimination period is, because this can help you determine how much of an emergency fund you should keep.

There are two main categories of disability insurance:

  • Short-term – this type of policy can help cover up to 100% of your lost income for the first several months you’re disabled. The elimination period is usually very brief, a number of days.
  • Long-term – this type of policy will cover a lower percentage of your wages, often between 50-70% of your income. These benefits can last for years, sometimes until you’re age 65. The elimination period is commonly 3-6 months.

If you have Group Insurance, you probably have both types of coverage, with the short-term policy providing coverage during the elimination period for the long-term insurance.

If you buy Private Insurance for yourself, you typically start with a long-term policy. You may choose to supplement it with short-term disability coverage, or you may plan to use your own cash reserve to meet your needs for the elimination period.

A few thoughts on how much long-term disability insurance you should own:

  • As a default starting point, we generally recommend you obtain coverage for at least 60% of your salary.
  • If you have financial dependents, such as children or a nonworking spouse, you may want a higher level of coverage.
  • If you have student loans (or other financial obligations), you may want a higher level of benefits because it is difficult to have student loans discharged due to disability.
  • Consider how your benefits will be taxed. If you receive benefits from a Private Disability Insurance policy that YOU paid for, you will often receive the benefits tax-free. However, if your employer paid for your coverage, these benefits will typically be taxed.

There are also two definitions of disability for you to be aware of. Make sure you understand which definition is used in your policy.

  • Any occupation – this type of policy will pay benefits only if you are unable to perform “any gainful occupation”, including a part-time job that could be totally unrelated to your current career. For example, if a neurosurgeon injures his hands, he can no longer work as a neurosurgeon but he can probably find plenty of other jobs. Because of this, he would not receive any disability insurance benefits if he had “any occupation” coverage. The insurance company doesn’t care whether his new job pays as much as his neurosurgery occupation. Clearly, this is not ideal for him.
  • Own occupation – although it is typically more expensive, you would prefer to have this level of protection, because you will receive benefits as long as you are unable to perform your own current occupation. The neurosurgeon we mentioned above would be much happier to have this kind of disability insurance!

In addition to these insurance policies, you may also receive benefits from certain government programs, including the Social Security Administration. However, these programs provide fairly limited benefits and can be more difficult to qualify for2. Your best plan is to make sure you have your own disability insurance coverage in place, just in case the worst happens.

If you are worried about how your family would be affected by a loss of income due to disability, talk to a financial advisor. We are happy to help review your financial plan, including your insurance portfolio, to make sure that you and your family are well protected.

 

1 Per a study published by the SSA: https://www.ssa.gov/oact/NOTES/ran6/an2018-6.pdf. The Social Security Administration estimates that, if you were born in 1991, your probability of disability before reaching normal retirement age is 26.8%, while your probability of death in that same time period is only 7%. (If you’re slightly older, born in 1966, the numbers are still similar - your probability of disability is 28.1% and probability of death is 7.7%).

2 The Social Security Administration defines disability as the “inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment(s) which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months.”

 

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