One of the chief disadvantages of self-employment is that when you become sick or disabled, you can’t just take some sick leave like many employees can at their jobs. When you’re not working, you’re not making money. But insurance policies regarding disability for self-employed individuals is a vitally necessary form of insurance protection that can replace your earned income if you become incapacitated for any reason.
- Group vs. Individual
- Morbidity Statistics
- Long vs. Short-Term
- How They Work
- Don’t Be Cheap
- Benefit & Elimination Periods
- Own-Occupation vs. Any-Occupation
- Partial Disability Benefits
- Accelerated Benefit Rider Alternative
Group vs. Individual
Most employees who buy this form of protection are able to get into a group policy at a reduced cost, but you won’t have this luxury unless you own a business with several full-time employees under you and can get a group policy for your company.
If you have no employees, then you’ll have to buy a standalone individual policy. These usually cost more than group policies, but the money you spend on them is worth it in the long run.
Statistics show that one in four workers who are in their early twenties today will become disabled for at least some period of their lives, or perhaps permanently. You are several times more likely to become disabled than you are to die prematurely, and disability can be far more devastating than death.
- If you die, then your life insurance (assuming you have some) will pay out and can be used to cover medical and funeral bills.
- But if you become disabled, then you’ll have to have a way to pay your ongoing bills without working. The rent, mortgage and utility bills aren’t going to go away, and then you may also have medical bills or the cost of managed care to contend with as well.
Long vs. Short-Term Disability
Disability insurance can protect you from this dilemma by replacing a portion of your income while you are unable to work. There are two main types of disability insurance: long-term disability insurance and short-term disability insurance.
Short-term disability can last for up to two years, while any period of disability that lasts longer than this will be covered by long-term disability insurance. Some short-term disability policies will only pay out for three to six months before depleting their benefits. If you have enough saved to cover your living expenses for two years, then you may only need long-term coverage.
How they Work
Most disability policies today are “non-cancelable” and “guaranteed renewable”.
- This means that the disability insurance company cannot cancel your coverage for any reason as long as you continue to pay the premiums. Under certain circumstances, they may be able to raise your rates, depending on the terms of the policy.
Most long-term disability policies today will only cover 50-60% of your current earnings, so you may need to make some adjustments in your budget if you become disabled and begin receiving this income.
However, disability income is tax-free if you have not deducted the cost of the premiums on your tax return. If you do, then your disability payments will be counted as ordinary income. Some long-term disability policies have a benefit period of only five to ten years, while others will pay you until you reach retirement age (usually age 65).
Don’t Be Cheap
Of course, the more comprehensive the insurance coverage, the greater the cost of the policy, but this is one area in which it’s not a good idea to try and economize too much. By all means, you should do your homework and shop around to see where you can get the best protection at the best price, but make sure that the policy you choose will allow you to continue to function at least somewhat normally if you become unable to work.
You should work out a budget to see what your monthly bills will be if you were to become disabled, and then pay for coverage for at least that amount each month. If you hate the idea of spending so much money on a form of protection that you have a 75 percent chance of never using, then you may want to opt for a return of premium rider. This will increase the cost of the policy, but that may be much more palatable for you if you can eventually get all of your money back.
Benefit & Elimination Periods
All disability policies have two separate periods built into them. The benefit period is the amount of time in which the policy will pay benefits to the insured. As mentioned previously, this can be anywhere from three months until retirement age, depending on the policy. Disability policies also have deductibles that come in the form of a waiting period, known as an elimination period.
A short-term disability policy may have an elimination period of 90 days, while a long-term policy may not pay out until two years have elapsed. The longer the elimination period, the cheaper the policy will be. So if you have enough saved to cover six months of living expenses, then you would probably want a policy with an elimination period that is at least that long. Conversely, the longer the benefit period, the more expensive the policy.
Recent studies have shown that the average period of disability is about 35 months, so a policy with a five-year benefit period may be all you need if you are in good health.
Many disability policies also contain exclusions that prohibit the policy from paying out if you engage in certain activities, such as skydiving or driving a race car. It may also preclude payment for any preexisting health conditions that you may have, such as diabetes or cancer.
Most disability insurers will also need to see that you have earned income for at least the past two years, so you’ll need to have your past two tax returns handy when you shop or apply for coverage.
You may be required to show your business’s specific tax document, such as a form 1120S or K-1 if your business is a Subchapter S Corporation. If you cannot produce the necessary documentation, then you may not be eligible for coverage.
Own-Occupation vs. Any Occupation
Disability policies all fall into one of two categories. An “own-occupation” policy means that the policy will pay out if you become unable to perform the job you were working when you became disabled.
- This type of policy is therefore popular with high-income earners such as doctors and dentists, because a policy that wouldn’t pay out if they become unable to practice their professions wouldn’t be worth much to them.
“Any occupation” coverage will only pay out if you become unable to work any type of job.
So, if you are a small business owner with a high income, then you would definitely want to purchase an own-occupation policy so that you could replace the majority of your income. If you were to become unable to work your current job but could still work in the fast-food industry, then an any-occupation policy would be useless.
Partial Disability Benefits
Disability insurance can also pay out a lower monthly benefit if you become only partially disabled. It would pay out what is known as a residual benefit, which is a certain percentage of the full benefit that the policy would pay if you were totally disabled. If you are still able to work part-time at your current job, then the policy would pay you residual disability income to make up for the difference.
The Accelerated Benefit Rider Alternative
If you find the cost of disability insurance to be prohibitive, then you may want to consider purchasing a life insurance policy that has accelerated benefit riders that can pay out while you are living if you become disabled or are diagnosed with a critical illness.
This can effectively resolve the dilemma of having to pay premiums for a coverage that you may never use, as the death benefit in the policy will pay out if no other form of coverage is needed while you are living.
These riders are available for both term and permanent coverage, and they may be cheaper than a straight disability policy. An indexed universal life insurance policy that has these riders can provide both life and disability coverage as well as a savings component that you can use for retirement or any other purpose you choose.
Disability insurance should be a vital part of your financial plan if you are self-employed or own your own business. This type of coverage can effectively replace your lost earnings if you become unable to work for any reason. Your financial advisor or life insurance agent can help you to find a policy that best fits your needs and circumstances.
Unfortunately, many self-employed persons today do not have this form of protection, and those who do become disabled without it can face financial catastrophe. Don’t become another statistic; start shopping around for a disability insurance policy today. It may be one of the smartest things you’ve ever done.