If you are a high-income earner, then it is vitally important that you carry some form of disability insurance coverage. While you would probably never go without life or health insurance, you may think that disability insurance is not worth the money you would have to pay for it. But the Social Security Administration estimates that one out of every four 20 year- olds will become disabled for a period of at least 90 days before they reach age 67, and Web MD says the odds of becoming disabled for a period of time are even higher. Disability insurance should therefore be a vital part of your financial plan, as your greatest financial asset is most likely your occupation means.
Disability vs. Death
Most high-income earners base their financial plans on one or more life insurance policies as well as their health insurance. But many in this category overlook disability insurance in their financial plans, because they don’t think that they could ever become disabled.
But statistics show that you are several times more likely to become disabled at some point in your life than you are to die prematurely-and disability can be far more devastating financially than death.
If you are killed in a car accident, then you may incur some medical bills that aren’t covered by your health insurance and then have funeral costs on top of that. But your life insurance will most likely be able to cover those expenses, and then the expenses will stop.
But if you become unable to perform the substantial duties of your regular occupation, then you may need in-home care or even care in a nursing home facility for years to come, without any income coming in (unless your spouse also works). Disability insurance is therefore vitally important for this reason.
Types of Disability Insurance
Disability insurance can be categorized in a couple of different ways. One method of classification is by the benefit period and elimination periods of the policy. Short-term disability coverage usually has an elimination, or waiting period of anywhere from two weeks to 90 days, depending upon which policy you use.
This type of policy will generally pay out benefits for up to two years after the elimination period is satisfied. Long-term disability insurance usually doesn’t start paying out until a year or two after you become disabled, but it can pay benefits for three, five or ten years or even until you retire.
Own-Occupation vs. Any-Occupation
Disability insurance can also be classified according to the type of benefit it pays out and the definition of disability that it uses. Any-occupation disability insurance is the strictest type of disability policy, and this type of policy will only pay out if you become so severely disabled that you cannot work at any type of job, even a menial one. This can be a substantial disadvantage for high-income earners who, through injury or illness become unable to perform their duties at their chosen professions.
- For example, a doctor with a thriving practice and annual income of $400,000 per year who becomes unable to perform his material duties as a physician might not be able to collect anything from an any-occupation policy if he is still capable of working in the fast-food industry. This would obviously be financially disastrous for him, as he could not replace his previous income.
Fortunately, there is another type of disability insurance, one that will pay a benefit based upon whether you are capable of working in your chosen profession. The doctor in the example above who owns an own-occupation disability insurance policy will receive a much higher monthly benefit that is based upon the income that he earns in his regular occupation.
This type of true own-occupation definition is much more appropriate for someone in his position due to his higher income. Own-occupation disability coverage can be divided into three separate categories, depending upon the insured’s ability to work another job outside their chosen profession.
“True” Own-Occupation Disability Insurance
This is usually considered to be the best type of disability insurance on the market today. This type of disability insurance will pay you a monthly benefit if you become unable to work at your chosen occupation but are able to work at another job somewhere else.
- For example, if the doctor from the example above owns a true own-occupation policy and becomes unable to practice medicine, but is able to get another job as a research assistant earning $200,000 a year, then he would still get his full disability benefit on top of his new salary. For this reason, many doctors, dentists, lawyers and corporate executives choose to use this form of insurance in order to replace the income from their medical specialty or other area of expertise.
Of course, this type of coverage is also the most expensive; the doctor can most likely expect the annual premiums to be equal to anywhere from 1 to 3 percent of his annual gross income. But true own-occupation disability insurance can allow highly motivated individuals to get back out into the workforce and do something that they are still capable of without penalizing them.
Own-occupation disability coverage defines disability as the physical or mental inability for you to perform the substantial duties of your occupation, regardless of whether you are still qualified to perform some other line of work.
True own-occupation policies will always specifically identify themselves as such, and the language contained in the policy will explicitly state for its definition of total disability that as long as the insured is unable to perform their chosen occupation that they worked at for the previous year before they became disabled, then they are considered to be totally disabled.
“Transitional Own-Occupation Disability Insurance
This type of disability insurance is not as generous as true own-occupation disability coverage. Transitional coverage will reduce your monthly benefit amount by any amount that you are earning from another job. The doctor in the examples above would have his disability benefit reduced by $200,000 a year if he owned a transitional own-occupation policy. He is not free to go work another job without having his benefit reduced proportionately.
However, this type of coverage is also less expensive than true own-occupation coverage. The sample language in a transitional own-occupation policy says that if you become unable to work in your chosen profession, but are still able to find gainful employment elsewhere that your monthly benefit will be either the lesser of the maximum transitional occupational benefit or your loss of earnings minus benefit that are paid out from other disability policies (if you have them), down to a minimum of perhaps 25% of your monthly transitional occupational benefit.
You can still receive benefits of up to 100% of your previous earned income if you work in another occupation, but the total benefit won’t exceed the maximum monthly benefit outlined in the policy.
“Not-Engaged” Own-Occupation Disability Insurance
Also referred to as modified own-occupation insurance, this is the most restrictive type of own-occupation policy available today. Also referred to as “modified” own-occupation insurance, this type of policy will not pay you a benefit if you are able to work another job of any kind.
But you don’t just have to be able to work another job, you actually have to work it in order to disqualify yourself from receiving benefits. The sample language in one of these policies would say that you must be totally disabled and unable to work in your chosen profession and are also not working elsewhere.
“Adjustable” Hybrid Policies
Some insurance companies have created policies that provide some form of own-occupation coverage for a specific length of time, such as two years. At the end of that time, the policy will then adjust to an any-occupation policy, which may prevent further benefits from being paid out.
If you own one of these policies and become totally disabled, then during the initial benefit period you can work another job and still receive benefits as with a true own-occupation policy until the period ends. If you are then able to work any other type of job at that point, then benefits will cease.
The sample language in this type of policy might say that up to a certain length of time of being totally disabled, you will receive true own-occupation coverage. After that time has expired, you will cease to receive benefits if you are able to work any type of job.
Residual Disability Insurance
If you become only partially disabled but are still able to work in your chosen profession, then you may qualify for residual disability benefits. In this case, the insurance company would calculate a monthly benefit for you based upon the degree of your disability.
This benefit would equal a certain percentage of your full benefit, depending on the nature of the disability. For example, if the doctor in the examples above suffered a partial disability but was still able to come in to work two days a week, then the insurer may pay him a benefit equal to 60% of his maximum benefit.
The tax treatment for disability insurance is fairly straightforward. If you have paid the policy premiums out of pocket and did not deduct the cost of those premiums on your tax return, then the benefit will be tax-free to you. On the other hand, if you did deduct the cost of the premiums, or your employer paid for your policy using pretax dollars, then the monthly benefit will be counted as ordinary income. This means that it will be taxed at your top marginal tax rate.
Most disability insurance policies contain a set of exclusions for which they will not pay benefits. If the insured has a preexisting medical condition, such as cancer or diabetes, the insurer may refuse to provide coverage for that condition, or delay payments for an additional length of time. Most policies will also exclude disabilities that were sustained from “risky” activities such as mountain climbing or skydiving.
Non-Cancelable & Guaranteed Renewable Policies
All disability insurance policies can be further classified into one of three categories, regardless of whether they are true, residual, not-engaged or adjustable disability insurance policies.
1. Non-cancelable and Guaranteed Renewable
2. Guaranteed Renewable
3. Conditionally Renewable
The first type of policy is generally considered the best kind, as it guarantees that the insurance company will never raise your rates and cannot cancel your coverage for any reason as long as you continue to pay the policy premiums.
If you purchase one of these policies when you are 25, then you’ll pay that same premium over the life of the policy, and the terms of coverage will remain the same. Neither your benefits nor your premiums will change, and you’ll have the exact same coverage 20 years from now that you have now.
Straight guaranteed renewable policies don’t have quite the same guarantees that a non-cancelable policy does. With guaranteed renewable policies, the insurance company cannot cancel your coverage for any reason, but is allowed to raise your rates according to one or more of three factors:
1. By the state your policy was purchased in
2. By the year your policy was purchased
3. By your occupation
The insurance company will periodically review its book of business to evaluate how well it is performing. If it is not performing well, then the insurance company may raise its rates in these policies with the approval of the state insurance commissioner. However, straight guaranteed renewal policies are also less expensive than their non-cancelable cousins (at least initially).
Conditionally renewable policies are commonly found in employer-sponsored group or association plans. This is the riskiest form of policy to own, because you may have to pass a medical exam at some later date if you want to keep the policy in force. If you cannot pass the exam, then you lose the coverage permanently. Of course, this is also the cheapest type of policy available, but it may not be there for you when you need it if you have health issues.
Own-occupation disability insurance provides the most comprehensive form of protection available in the marketplace today. When you shop for disability insurance, find out how much “true” own-occupation coverage that is both non-cancelable and guaranteed renewable. The extra cost will most likely be worth your while. Consult your financial advisor or insurance broker for more information on disability insurance.