If you’re wondering whether you should buy disability insurance, then you’re not alone. A growing number of people are coming to realize that this form of protection is vitally necessary if they should become disabled for any material length of time. Statistics show that a 20-year old today has a one in four chance of becoming disabled at some point in their lives, and disability can create a considerably larger financial burden than death.
- Death vs. Disability
- Who Needs It?
- Types of Disability Insurance
- Coverage Limits
- Tax Rules
- Non-Cancelable & Guaranteed Renewable
- Policy Riders
- How Much Does it Cost?
- Personal Factors
- Policy Factors
- Where to Buy
- Issues to Consider
Death vs. Disability
The definition of disability is when you become physically unable to perform your duties at your job for a material length of time. If you die prematurely, then your life insurance can cover your medical and funeral bills and the bills will stop at that point.
But if you become disabled, then not only will you not be able to bring home a paycheck, you may have other ongoing healthcare expenses that you will to pay for out of your own pocket. And your health insurance may not cover all of the costs of in-home or managed care, leaving you to come up with the difference.
Also keep in mind that 90% of disability claims are due to illness and not injury. The actuarial life table that was most recently published by the Social Security Administration estimates that the average 45-year old male only has a 0.34% chance of dying, while the chance of becoming disabled is higher.
And insurance analysts contend that one in seven people become disabled for a period of at least 5 years before they reach age 65. These statistics are hard to ignore, and they spell out that this is a very real risk.
Who Needs Disability Insurance?
While you know that you’re going to die eventually and there is some chance that you could die prematurely, you may think that you will never become disabled, at least until you reach old age. But if you are the primary (or even the secondary) breadwinner in your family, then you probably need some form of disability coverage.
While short-term disability may be more of a luxury, long-term disability is a type of protection that the vast majority of people need, at least to some extent. This is especially true if you have children or other dependents. So the question of whether you should buy disability insurance is usually not going to be a matter of “if”, but of how much and what type of coverage best fits your needs.
However, if your annual income is below $30,000, then private disability insurance may not be a practical solution for you. Also, if you are already retired or are living off of your investment income, then you don’t need disability insurance (although you may still be a good candidate for life insurance).
Types of Disability Insurance
There are a few different types of disability insurance available in the marketplace today, and the right type for you will depend on such factors as your current income and expenses, the amount of money that you can spare to pay the policy premiums and the state of your health.
- Own-Occupation Policies
- All disability policies fall into one of two categories. Own-occupation disability policies will pay you a benefit if you should become unable to work at your present occupation. This affords you a higher level of protection and also costs more.
- Any-Occupation Policies
- Any-occupation disability insurance is cheaper, but it will only pay you a benefit if you become totally disabled and are completely unable to work at any type of job. Therefore, if you are a high-income earner, then you will probably want to look at an own-occupation policy. The premiums will be higher than for an any-occupation policy, but you’ll be glad that you paid them if you are a computer programmer and become unable to continue working at your current occupation but are still able to work a menial job of some kind, such as in the fast-food industry.
- Long vs. Short-Term
- Another way to classify disability policies is by the period of time over which they will pay benefits, known as the benefit period. Short-term disability insurance generally lasts for one to two years and may start paying out as soon as one month after you become disabled. Long-term disability insurance usually doesn’t start paying out until you have been disabled for at least two years. These policies may pay out benefits for three, five or ten years or even until you retire in some cases. If you’re looking to cover yourself for a long-term disability, remember that the average long-term disability claim lasts for about 35 months. But if you currently have health issues and feel that there is a real chance that you could eventually become permanently disabled, then a policy that would pay you until you reach retirement age (usually age 65) may be necessary.
- Short-term policies are much less expensive than long-term policies. Both types of policies have a deductible that comes in the form of a waiting period known as the elimination period. This period usually ranges from three to six months for short-term policies and is seldom less than two years for long-term policies. But the longer the waiting period, the less expensive the premiums. If you have a large emergency fund, then short-term coverage may not be necessary.
No type of disability policy will pay you 100% of your current income if you become disabled. Most long-term policies will pay you a monthly benefit of 60% of your previous earned income, while short-term policies may pay out up to 80% of your previous earned income.
Insurers do this because they don’t want to incentivize you to stay home from work and continue collecting benefits.
However, your monthly expenses may go down in some areas if you become disabled; for example, you may not be able to drive a car or engage in recreational activities, which could reduce your expenses.
But don’t forget to factor retirement savings into the amount of coverage that you get, because you will no longer be able to contribute to your employer’s retirement plan if you become disabled.
The taxation of disability insurance income is fairly simple. If you paid for the premiums out of pocket and didn’t deduct them on your tax return, then the monthly benefit that you receive will be tax-free. If you deducted the cost of premiums, then your benefit will be taxable.
It will also be taxable if your employer paid your policy premiums using pretax dollars. If your disability income is taxable, it will be taxed as ordinary income, which means that it will be taxed at your top marginal tax rate.
Non-Cancelable & Guaranteed Renewable
Most disability insurance policies today are either non-cancelable or guaranteed renewable (or both), which means that the insurance company issuing the policy cannot cancel your coverage, reduce your benefits or increase your premiums for any reason as long as you continue to pay the premiums.
Guaranteed renewable policies can raise their rates if you file a claim or do other things that could increase your risk of becoming disabled, but they also cannot be canceled if you continue to pay your premiums.
However, the increase in rate must apply to an entire block of customers and not just one person. Stay away from conditionally renewable policies, because the insurer can deny you coverage later on if it feels that the odds of you becoming disabled have risen. And another benefit of non-cancelable disability policies is that your benefit will stay the same even if your actual earned income declines.
If you get laid off from your current job and are forced to work elsewhere for less money, then you’ll still get the same benefit from your disability policy if you become disabled.
Most disability policies will contain a few exclusions for high-risk activities such as skydiving or driving a race car. If you work in a hazardous occupation, such as law enforcement or construction, then certain items may also be excluded from coverage. Y
our insurance carrier may also limit or refuse coverage based on disability due to one or more existing health conditions. For example, if you are battling cancer, then your disability insurer may exclude any cancer-related disability expenses that you incur.
Many disability policies come with additional riders that you can purchase in order to custom-tailor your policy to meet your needs. One of the most common riders is the cost of living rider, which will help your monthly benefit to keep pace with inflation if you have a claim.
How Much Does Disability Insurance Cost?
In general, a long-term disability insurance policy will usually cost anywhere from 1-3% of your annual income. But this will depend heavily on several factors relating to both you and the policy you choose. A list of these factors includes:
- Age – The older you are, the more expensive the policy will be.
- Gender – More disability claims are filed by women than men, so their policies are more expensive.
- Smoking History – Smokers will pay higher premiums than nonsmokers.
- State of Residence – Insureds in states where more disability claims have been filed will pay more than those in states with lower incidences of claims.
- Occupation – As mentioned previously, those who work in hazardous occupations will pay more in premiums than those who work safer jobs, such as in an office.
- Amount of Coverage – Policies that pay higher benefits will be more expensive.
- Benefit Period – Longer benefit periods means higher premiums.
- Elimination Period – Longer elimination periods mean lower premiums.
- Policy Provisions – Own-occupation vs. any-occupation, guaranteed renewable or non-cancelable
- Riders – Any additional riders will add to the cost of the policy.
Where Can I Get Disability Insurance?
There are several ways that you can shop for disability insurance plans. Your employer may be your best bet, as it may offer you access to group coverage, which will be less expensive than a standalone policy. However, you will lose that coverage if you leave your employer.
But if you want short-term disability coverage, then that can only usually be offered on an economical basis through an employer.
Your financial advisor or life insurance agent will also most likely have a few different policies to choose from, or you can look online using a search engine. There are dozens of insurers to choose from online, and you’ll need to shop around to see where you can get the best deal.
Some disability insurers specialize in offering policies that cater to specific occupations, such as law or dentistry.
Issues for Consideration
You may have trouble sifting through all of the information you can find online or receive from your financial advisor when it comes to finding the right disability policy.
And disability insurance companies such as Guardian, Massmutual, Mutual of Omaha, Northwestern Mutual and Thrivent have all received the highest possible ratings from the rating agencies.
Alternatives to Traditional Disability Insurance
When it comes to disability insurance, there is not much out there in the way of alternatives to traditional disability coverage. Social Security Disability (SSDI) insurance coverage is available, but this protection is very difficult to qualify for.
Over 60% of all applications are rejected immediately, and the average monthly benefit is only about $1,100. You must be severely incapacitated to receive this coverage.
Workers’ Compensation can also provide you with disability benefits, as long as you incurred your disability on the job. But it will not pay benefits for any disability that arises from outside the workplace.
If your earned income was below $30,000, then Medicaid, Supplemental Security Income and state-sponsored disability programs may provide you with sufficient coverage.
If you currently have no disability coverage, now is the time to talk to your employer or financial advisor about getting some. Disability can lead you into financial ruin if you’re not prepared for it. And it’s more common than you think.