Protecting assets is a key element of financial planning. While not usually the first one we think of, one of your most valuable assets is your ability to earn a living.
Homeowner’s insurance protects you from the loss of your home and you probably have health insurance to protect you from significant losses due to medical bills. How do you protect your ability to earn a living? Disability insurance.
It’s not always fun to think about insurance. Paying premiums month after month can feel like you’re spending money on a benefit you may never use. If you are young and healthy, disability insurance may especially feel this way. You should know, however, that 1/3 of employed Americans will become disabled for at least 90 days at some point in their career. Furthermore, the average disability lasts 13 months, and mortgage foreclosures for disabilities are 16 times higher than foreclosures after a premature death.
Disability insurance can be a welcome cushion if you are in a car accident or have an unexpected, debilitating illness. Disability insurance pays a portion of your income if you are unable to work due to illness or injury.
Four types of people should definitely make sure they have adequate coverage if they become unable to work:
- Primary income earners for a family without significant savings.
- People in physically demanding jobs – after a car accident it might be easier to go back to work if you are a computer programmer, but it could be much more difficult if you are climbing utility poles or staying on your feet most of your workday.
- Stay at home parents or primary caregivers for children or seniors. It can be very expensive to replace a caregiver.
- People who already have recurring injuries which could interfere with their ability to work.
What is Disability Insurance?
If you are physically unable to work for a period of time, what happens to your income? With few exceptions, your income will probably stop. Your bills, however, will not.
Being injured and out of work will be stressful enough without the added stress of falling behind on bills and other day-to-day expenses. That income loss could snowball into other issues like accumulating more debt, relying on family and friends, or losing some assets.
Many policies pay up to 60% of your income, providing a solid financial cushion. Disability insurance can help you stay current on your primary financial needs so you can focus on getting better. With disability insurance, you’ll still be able to pay for necessities like rent, groceries, and utilities. While it doesn’t cover everything, a disability insurance policy can prove invaluable.
Disability insurance should not be confused with Workers’ Compensation Insurance, which covers injuries sustained on the job. Workers’ Compensation insurance is provided by employers by law, and may cover the costs of retraining as well as income support.
How Does Disability Insurance Work?
A disability policy works like other types of insurance. You agree to pay regular premiums, and in exchange, the insurance company assumes some form of risk. In this case, the risk is that you become disabled. The insurance company assumes this risk for you by agreeing to pay you a portion of your regular income.
It’s important to understand your policy agreement. Specifically, it is critical to know how disability is defined (this varies from policy to policy), the period your benefits cover, and the exact benefit level you’ll receive.
Disability policies also have a unique feature called an elimination period. This is the amount of time you have to be disabled without coverage, to meet the policy’s definition of disability. Once your disability has been established to the satisfaction of the insurance company, your benefits will start. Usually, this is 90 days, but you can reduce your premium by opting for a longer elimination period.
What Does Disability Insurance Cover?
Disability insurance will pay you a portion – but not all – of your lost income. The typical arrangement is 60% of your gross income, so it likely won’t cover all of your normal expenses but will go a long way to keep you from getting buried in bills.
Remember, your health insurance is for medical bills; disability insurance covers other living expenses. Your disability policy pays for a definitive period that depends on the type of policy you have: short-term or long-term. (More on that in the next section.)
Check your policy to see what is specifically covered. Your policy may cover you for partial disabilities, meaning you can’t perform certain necessary tasks, or total disability, meaning you can’t work at all. Some policies even cover pregnancies.
Below are some examples of potential coverage opportunities:
- Musculoskeletal issues (arthritis, back, joint, etc.)
- Respiratory illness (asthma)
- Heart disease
Disability coverage is policy-specific, so be sure to consider all coverage options and limitations before selecting a policy. Your Abacus advisor can help review your options to ensure that the coverage fits your short-term and long-term needs.
Short-Term vs Long-Term Disability Coverage: What’s the Difference?
Disability policies can either be long-term or short-term. A short-term policy will typically pay out for a few months to a year, after an elimination period of just a few weeks. Most often, a short-term policy replaces between 60% and 70% of your income.
Long-term policies are meant to cover a disability lasting for an extended period. Normally, the elimination period is 90 days but the policy will pay out for many years as the name suggests. Most long-term policies will replace 40% to 60% of your income.
Since short-term policies offer benefits for a reduced time, the income coverage is typically higher. Someone collecting short-term disability for 6 months will cost the insurance company far less than another person who needs to collect benefits for 5 years.
Do you need both types of coverage?
Everyone’s insurance needs differ, but many short– and long-term policies work together. If you have both, short-term benefits cover your immediate needs and when that policy dries up, the long-term benefits kick in.
Where Can You Obtain Coverage?
You can obtain disability policies similar to getting health insurance – either provided by your employer or by shopping on your own.
Your employer may provide disability insurance through a group plan as part of your benefits package. Just as most companies cover a portion of your health insurance premium costs, many cover a portion of your disability premium as well. That often makes disability insurance much more affordable.
However, you can also look outside work if the policy doesn’t fit your unique needs or you can get a better rate elsewhere. One perk to an open market policy is you don’t have to switch plans if you change jobs.
You could also get both an employer-provided plan and a private policy if you want to fill gaps in your coverage. Your Abacus advisor can help you conduct an insurance review to see if you have the appropriate coverage and whether your policies are aligned with your needs.
How Much Does a Policy Cost?
The cost of a disability policy will normally be 1% to 3% of your income and depends on what influences the likelihood you will become ill or injured. The more risk factors you have, the higher your premium will be. Examples include:
- Where you obtain the policy (work, individual, combination)
- The coverage/benefits you want
- Add-ons or riders
- Current health
- Lifestyle habits (such as smoking)
- Occupation – jobs with higher risk often have higher premiums because the chance of injury is greater
Do You Need Disability Insurance?
More than 1 in 4 people in their 20s will encounter a disability before retirement age, according to the Social Security Administration. Can you afford to live if your paychecks stop?
The right coverage for you depends on your health, occupation, finances, other insurance coverage, income needs, and so much more.
We’d love to help protect your income for years to come. Call us today to discuss how an Abacus advisor can help you find peace and ease around your future.