Life insurance replaces your income for your dependents after you pass. But what if you need to replace your income while you’re still alive and disabled?
Becoming disabled and not being able to work is more common than you’d think. In fact, you are three to five times more likely to become disabled than to pass away prematurely, yet people are more financially prepared for their potential premature death than disability!
The reality is, people get injured on the job, have serious car accidents, or lose their ability to work due to a debilitating illness every day. No matter how safe you are or how committed you are to healthy living, unfortunately, life may throw you a curveball when you least expect it. It’s important to do what you can to prepare for this possible hardship. It’s not about living in fear; it’s about being proactive and taking responsibility for whatever life deals you.
If you are looking to learn about the basics and benefits of disability insurance, how much of it you need, and other ways to plan for disability, this series is a great starting point.
Defining “Disabled”
The purpose of disability insurance is to replace your income for you and your dependents if you become disabled and can’t work. The word “disabled” can mean different things depending on the type of policy you get. The two most common definitions of disability include “own occupation” and “any occupation.”
An own occupation policy provides coverage if you are disabled and can’t perform the duties of your specific occupation, even if you are still physically and mentally able to work in another occupation. For example, surgeons are compensated not only because of their skill but because of their knowledge. An injury could take away their skill of performing surgery but leave them with the knowledge to teach, manage the surgery center, or consult. Typically, these alternative occupations pay less than performing surgeries.
An own occupation policy protects against this because even though the surgeons can work in other knowledge-based positions, they will be covered for their inability to perform their specific duties of performing surgeries. This policy tends to be more expensive because the policy is specific to your profession, thus more likely to be paid out by the insurance company.
In contrast, an any occupation policy provides coverage only if you cannot perform the duties of any occupation for which you are suited by education, experience, and training. Let’s look at the previous example of being a surgeon. If you had any occupation disability policy in that situation, you would not be covered because you are able to work in another position that requires your knowledge of the field.
Any occupation policies tend to be less costly because the insurance company is less likely to have to pay out benefits since the policy is stricter on what’s covered.
Types of Disability Insurance
Another way that disability insurance policies can differ is whether it is a short-term or long-term policy, or in other words, how long the policy will provide benefits.
Short-term disability policies provide a benefit to you for three to six months, typically 40-70% of your lost wages. To qualify for short-term disability, a medical professional has to deem you unable to perform your job for that period of time, with the expectation that you will recover from your injury or illness relatively quickly. In some cases, short-term disability may need to be extended up to a year, and if it’s used in combination with a long-term disability plan you may need to transition into long-term coverage.
The advantage of having a short-term disability plan is that you’re covered if something serious enough to keep you out of work happens, but not devastating enough to prevent you from working for years. Short-term disability is more likely to occur than long-term, but it’s important to note that even short periods without a paycheck can be difficult for many families.
Keep in mind, some short-term disability policies are taxable, depending on whether you fund it with pre-tax or post-tax income. It’s likely that a plan through your employer is pre-tax, meaning you’ll need to pay taxes when you receive the benefit. A private plan is likely one you’ve purchased with money you’ve already paid taxes on and therefore will not be taxed when the benefit is paid.
Long-term disability policies provide a benefit to you that can last 2 years, 10 years, or even until retirement. It typically covers 60-80% of your lost wages. It often kicks in once your short-term disability benefits have been exhausted, once the medical burden of proof has been met. Qualifying events for long-term disability can include a disabling injury, chronic pain, cancer treatments, or a debilitating illness. Like short-term coverage, long-term disability may also be subject to tax, depending on whether it’s funded with pre-tax or post-tax income.
A key feature of disability insurance is the elimination period, which is the amount of time you must wait until the benefits start kicking in. Typically, elimination periods for short-term policies are shorter (less than 14 days) while long-term policies have longer waiting periods (30-720 days).
Premiums
The cost of a disability policy can vary greatly depending on a number of factors, including the benefit length, amount, occupation, gender, age, and policy riders. A rule of thumb is that you can expect to pay between 1 and 3 percent of your projected annual salary.
The amount you or you and your employer pay for the policy is a premium, which usually ranges from $25 to $500. The amount is generally based on factors specific to your situation, such as your occupation, gender, age, and benefit amount.
The cost goes up as you age. Men pay less than women, but their rate increases faster as they age. People in hazardous occupations pay more. And if you have a history of chronic health conditions, you will pay more. Factors such as the coverage amount, benefit period, and waiting period can affect cost variations as well, depending on your selections.
The types of premiums for disability insurance policies may also differ.
With a level premium, you pay a fixed amount for the life of the policy. With this premium structure, you are paying more of the insurance cost up-front. The other kind of premium offered is a graded premium. With this premium structure, the premium slowly increases with time, thus the up-front cost of the policy is lower than a level premium policy.
Everyone’s disability insurance needs are different, so feel free to reach out to us if you have any questions regarding how disability insurance could be a piece of your financial plan. This information is not intended to be a substitute for specific individualized advice, and we suggest you discuss your specific situation with a qualified financial advisor.
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
