Disability insurance is a type of insurance policy that will pay you a percentage of your income if you can no longer work due to a disability, injury or illness. It is probably the most overlooked type of insurance, yet it is arguably the most important. When people think of a disability they imagine the worst. A freak accident or some other uncommon occurrence, but the reality is people miss work for many different causes like back pain, mental illness, diabetes, arthritis and heart disease. I can not think of anything worse than going from being the family breadwinner to becoming the family financial burden in the blink of an eye. If you were laid up not able to work for multiple years how long would you be able to go without a paycheck coming in?
According to the Social Security Administration over 1 in 4 of today’s 20 year olds can expect to be out of work for at least a year because of a disabling condition before they reach the normal retirement age. If you would like to learn more about the chances of becoming disabled, a great resource is a non profit organization called The Council for Disability Awareness. Check it out! They have a wealth of information available.
There are two types of disability insurance - short term and long term.
Short term is usually for less than a year and could have an initial waiting period (also known as elimination period) of a few weeks before benefits start paying.
Long term policies have many different options when it comes to how long the benefit continues to pay if you remain unable to work. For example, you can choose a 1 year benefit period, a 5 year benefit period or until you reach age 65. The longer the benefit period you choose the more the policy will cost. Long term policies will also have an elimination period before benefits start to pay.
Do you need disability insurance? Here is the only question you need to ask yourself:
If you were in an accident and could not work how long would you survive financially?
You have to take into consideration all options when answering this question. For example, would you receive some disability benefit at work? Can you tap into retirement accounts in an absolute worst case scenario? Can you move in with a family member to save on living expenses? You have to actually imagine what you would do in that situation and then decide if it is possible to survive without your paycheck for a certain period of time. Most people fall into the camp of not being able to get by for very long at all. If that sounds like you then yes - you need disability insurance.
On the other hand if you have a bunch of rental properties kicking off some good income each month and you have a few hundred grand in the bank then maybe you can survive a few years without a paycheck. Disability insurance might not be so high and your to do list.
How can you get Disability Insurance?
#1 Employee Benefits Package
Some employers offer short and long term disability insurance as part of their benefits package at no additional cost.(very cool) If that is the case for you here are some things to research and consider:
What is their definition of disability?
Do you have to be totally disabled for benefits to be paid?
Can you work part time and still receive benefits?
When does coverage start and when does it end?
What percentage of your income will you receive?
If your employer is paying the cost your benefit will be taxed.
Coverage ends when you leave your employer or if the employer decides to stop offering the benefit.
# 2 Voluntary Benefits through Work
Some employers offer a discounted group policy that you can voluntarily purchase. Here is what you should consider in addition to the items listed above:
Limited to no underwriting making it easy to obtain coverage.
If you pay with pre-tax dollars your benefit will be taxed, but if you pay with after-tax dollars then your benefit is tax-free.
In most cases you can not take your policy with you if you change jobs.
You can not customize the policy to your specific needs.
#3 Purchase an individual policy on your own
Personally, I think this is the best way to go, but it definitely depends on your job type and health history. It does require you to go through an application and underwriting process with an insurance company and it can cost much more depending on your age, gender, line of work, health and the options you choose. If you have a pre-existing condition like lower back problems they will be excluded from your coverage. You still need to research all the question we listed above like how much of your income can you insure and what is the definition of disability. Picking the right insurance company is also a big factor.
The best part of purchasing an individual policy is that it is yours. You take it with you wherever you go as long as you continue to make the premium payments. Another important point is if you are paying the premium for the insurance with after tax money then your payout will be tax free if you become disabled. This means a $6,500 monthly tax free benefit is around the equivalent of a $10,000 a month salary depending on your income tax rates.
You can also customize the policy to meet your specific needs. There are many different important choices to consider when purchasing an individual policy. For example, you can have the policy cover your “own occupation” meaning if you are no longer able to perform your specific job then the policy will pay the benefit. This is important for specialized jobs like athletes, entertainers, surgeons, dentists, etc. A lower cost option is to have your policy only cover you if you can not work in “any occupation” meaning you can not even work at the grocery store. It is super important to get these decisions right or it could result in the policy not covering what you intended when you purchased it.
When making these decisions do tons of research and work with a knowledgeable advisor that is a fiduciary acting in your best interests. I always recommend that you hire a "Fee Only" Certified Financial Planner™ to figure out the best options and then go complete the transaction with an independent insurance agent. Investing a few hundred bucks to get professional unbiased advice can make a huge impact on your entire financial life.