Dictionary.com defines disability as:
- A lack of adequate power, strength, or physical or mental ability; incapacity.
- A physical or mental handicap, especially one that prevents a person from living a full, normal life or from holding a gainful job.
The life insurance industry has three separate definitions of disability:
- Total Disability – You are physically unable to continue working in your current occupation, but you are receiving medical care designed to restore you physically to where you were before you became disabled.
- Partial Disability – You become injured or ill and need medical care, but are still able to work to some extent, albeit with reduced responsibilities or compensation.
- Presumptive Disability – You suffer an illness or injury that is so devastating that your disability insurance company classifies you as being permanently disabled.
- What is Long-Term Disability Insurance?
- Who Needs LTD Insurance?
- Types of LTD Insurance
- Own-Occupation Policies
- Hybrid Policies
- Non Cancelable & Guaranteed Renewal Policies
- LTD Insurance Riders
- Coverage Limits
- Tax Treatment
- Cost of LTD Insurance
- Where To Buy LTD Insurance
You know you’re going to die eventually, but you may not think that disability insurance is worth it to pay for. Unfortunately, disability in the U.S. is far more prevalent than you think. Insurance adjusters maintain that one person out of seven will become disabled at some point in their lives before they retire.
And being unable to work for this long can be financially devastating in many ways. If you die, then you may have some medical and/or funeral bills that will hopefully be covered with life insurance. But if you become disabled, then you may need expensive ongoing treatments without any money coming in.
Long-term disability insurance is designed to cover this gap and provide you with the financial protection you need. The Council for Disability Awareness has estimated that one in four 20 year olds today will suffer from some type of disability before they reach retirement.
What is Long-Term Disability Insurance?
Long-term disability insurance is a type of policy that will begin making regular monthly payments to you if you become disabled for an extended period of time. It will begin making payments after you have satisfied a waiting period known as the elimination period.
It stands in contrast to short-term disability insurance because it has a longer benefit period. Short-term disability plans will typically only pay benefits for a maximum of one to two years, while long-term disability plans may pay out for three, five or ten years or even until you retire in some cases.
Long-term disability insurance is more expensive than short-term disability plans, which can usually only be purchased on a cost-effective basis through an employer. But many employers also offer long-term disability insurance, which can provide coverage for a much longer period of time.
Who Needs Long-Term Disability Insurance?
If you are the sole or primary, or even secondary breadwinner in your family, then you probably need at least some form of disability coverage. If you are retired or living off of your investments, or you make $30,000 a year or less, then you are not a good candidate for this type of insurance.
If your income is below $30,000, then Medicaid, Supplemental Security Insurance and state-sponsored disability income programs can probably replace the majority of your income.
It is especially important that you have this type of coverage if you have children or other dependents that count on you for their financial support. So, to answer the question of whether long-term disability insurance is worth it, the answer is a resounding “Yes!”
Types of Long-Term Disability Insurance
As mentioned previously, long-term disability coverage usually doesn’t start paying out for at least two years after you become disabled. But the benefit period can be much longer than for a short-term policy.
Some long-term disability policies will pay you a monthly benefit until you reach age 65 or 70. Of course, this form of protection is considerably more expensive than any short-term policy, or even a long-term policy that only pays out for three to five years.
Long-term disability insurance policies can be divided into several different categories. The two main types of long-term disability categories are own-occupation and any-occupation. The key difference between these two types of insurance coverage lies in their definition of “disability”.
An own-occupation policy will pay benefits if the insured becomes unable to perform their own occupation, while an any-occupation policy will only pay out a benefit if the insured becomes unable to work any kind of job.
For obvious reasons, most high-earning professionals choose to pay the higher premiums for an own-occupation policy, so that they can get a benefit that approaches what they were making before they became disabled.
- For example, a doctor making $200,000 a year wouldn’t find much consolation with an any-occupation policy that would not pay anything out if the doctor became unable to work in his chosen profession, but could still hold a job in the fast-food industry.
Types of Own-Occupation Policies
There are three types of own-occupation policies available that pay varying degrees of benefits, listed below:
- True Own-Occupation policies – These policies will pay benefits even if you choose and are able to begin working somewhere else. They will pay out the full benefit every month, even if you are now making more in your new job than you were before. The insurance company may consider your general field, such as law or medicine as your specialty. You will need to find out from your insurance company how it classifies your occupation. If you are out of work or between job when you become disabled, then your insurance company will usually pay you benefits based on the last job that you had at which you worked for at least 30 hours a week.
- Transitional Own-Occupation policies – These policies are essentially the same as True Own-Occupation policies, except that they take into account any additional income that you earn from another job. For example, if your monthly benefit is $6,000, and you start working at another job that pays $4,000, then the insurer would reduce your monthly benefit to $2,000.
- Own-Occupation, Not Engaged policies – Also referred to as “modified” own-occupation coverage, this type of policy is the most restrictive of the three. It will not pay benefits if you work any other type of job after becoming disabled. It will pay benefits if you are able to work another job, just not if you actually do so.
There are also long-term disability policies that are essentially hybrids of own and any-occupation policies. For example, a policy might pay you an own-occupation benefit for a certain period of time if you become disabled, then revert to an any-occupation benefit.
The length of time that must elapse before the own-occupation benefits end will vary by insurance carrier and policy. In most cases, you can work another job during the initial benefit period without a reduction in benefits.
But if you’re still able to work after the initial benefit period ends, then the any-occupation benefit will not be paid.
Non-Cancelable & Guaranteed Renewable
The vast majority of disability policies today are either non-cancelable or guaranteed renewable or both. For non-cancelable policies, this means that the issuing insurance company cannot reduce your benefits, increase the premiums or cancel your coverage for any reason as long as you continue to make the premium payments.
And non-cancelable policies can still provide your current benefit amount even if you are forced to switch to a lower-paying job (assuming that your policy was not provided through your former employer).
Guaranteed renewable policies can raise your premiums under certain circumstances, but they must do it to an entire group of policyholders who share some common characteristic and not just a single customer.
Conditionally renewable policies can deny you coverage as you get older or develop new health conditions, so these policies should usually be avoided.
Long-Term Disability Insurance Riders
There are several types of riders that you can add to a basic long-term disability policy if you so choose. A list of these riders includes:
- Cost of Living Rider – This rider will ensure that your monthly benefits increase along with inflation so that you don’t lose your purchasing power.
- Future Increase Option Rider – If you are now earning more than you did when you initially took out disability coverage, then this rider will allow you to raise your policy benefits without the need for a new medical exam.
- Unemployment Waiver of Premium Rider – This rider will allow you to waive your monthly premiums if you lose your job for up a given length of time.
- Catastrophic Disability Benefit Rider – This rider will raise your monthly disability benefit to 100% of your current income if you become unable to perform at least two out of six activities of daily living (ADLs), such as eating, bathing or dressing, or permanently lose your sight or hearing. It will also pay out if you become cognitively impaired.
- Return of Premium Rider – Disability insurance can be expensive. So for those who are able to pay a slightly higher premium, this rider will refund some or all of your premium payments after a certain period has elapsed. The particular terms of this rider vary by product and company.
- Social Security Disability Insurance (SSDI) Rider – This rider will supply you with a measure of coverage while you apply for Social Security Disability Insurance (SSDI). If you are approved for Social Security disability, then the rider will subtract the amount you receive from them from your private monthly benefit.
- Automatic Increase Benefit Rider – This rider will automatically increase the monthly benefit that you receive for a certain period of time (such as five or six years). The rider is often added for free, but the premiums will increase during the years of increased benefits.
- Student Loan Protection Rider – This rider is only available for certain specified professions and loans. It adds an additional benefit to the rider that covers the cost of the insured’s student loan payments. (The additional benefit goes directly to the student loan lender and not to the insured.)
- Retirement Income Protection Rider – This rider will cover a portion a percentage of your retirement plan contributions.
Most disability insurance policies will only pay you a benefit equal to 60 or 70 percent of your previous earnings. This discount is used by the insurance companies to discourage you from malingering, or simply not working and continuing to collect benefits.
- The only exception to this is if you purchase the Catastrophic Disability Benefit Rider described above. Some disability policies also pay a residual benefit if you become partially disabled.
The carrier will calculate a percentage of your maximum possible disability payment and pay you that based on your disability.
But remember that your monthly expenses may also decrease somewhat if you become disabled. For example, if you become unable to drive, then your transportation expenses may decrease.
The tax rules for disability insurance are fairly simple. If you paid disability insurance premiums out of pocket and didn’t deduct their cost on your tax return, then your monthly benefit will be tax-free.
If you did deduct the cost of premiums, or your employer paid the premiums for you using pretax dollars, then your disability claims will be taxable as ordinary income. That is, it will be taxed at your top marginal tax rate.
Most disability policies come with several built-in exclusions in order to protect the insurer from claims submitted as a result of disabilities sustained from what it considers to be “high-risk” activities, such as skydiving, mountain climbing, flying in experimental aircraft or other such activities. Your insurer may also exclude any preexisting conditions that you have when you apply for coverage.
Cost of Long-Term Disability Insurance
The cost of your disability insurance policy can vary considerably based on your age, gender, health and occupation. But most policies cost anywhere from $500 to $1500 per year, or 1 to 3 percent of your gross income.
The amount of coverage that you choose to buy along with the benefit and elimination periods also factor heavily into this. All riders that you elect to include will also increase the cost proportionately.
Where Can I Get Long-Term Disability Insurance?
There are several places you can look for this type of coverage, starting with your employer. A group policy will usually be cheaper than standalone coverage, but remember that you’ll probably lose this coverage if you switch jobs.
Your financial advisor or life insurance agent can also help you to find a good policy. Companies such as Mutual of Omaha, Massmutual and Thrivent all offer good coverage at a reasonable price. You can also find quotes online.
Long-term disability insurance can be a godsend if you become unable to work for an extended period of time. One of the worst-case scenarios you can face is to be laid up with a major health condition with no income coming in. And your health insurance may not cover certain types of care, such as managed or in-home care. So, is disability insurance worth it?
Be sure to shop around before picking a policy; many carriers offer policies that cater to a specific profession, such as lawyers or CPAs. Consult your financial advisor for more information on long-term disability insurance.