If you are the primary (or only) breadwinner in your household, you probably wouldn’t even think of going without at least some life insurance to protect your dependents if something were to happen to you. And you may think that disability insurance is not necessary because it probably won’t happen to you. But the fact is, you are statistically several times more likely to become disabled for a period of time during your working years than you are to die prematurely. Both the Social Security Administration and the Council for Disability Awareness estimate that one out of every four 20-year olds in America today will have a period of disability lasting for at least 90 days before they reach retirement age. And since about three-quarters of Americans live from paycheck to paycheck, this can create a real financial headache for those who are caught unprepared. This is where short-term disability insurance can come into play.
- What is a Disability?
- Disability Insurance
- Long vs. Short-Term Disability Insurance
- How It Works
- Conditions for Renewal
- Tax Treatment
- Alternative Options
- Where to Buy
What is a Disability?
The definition of disability is outlined as any physical, mental or medical condition that prevents you from being able to perform the duties of your job. Illness is by far the most common cause of disability, with injuries coming in a distant second. Some of the common causes of disability include diabetes, cancer, depression and neurological disorders such as multiple sclerosis. Some insurers also count pregnancy or complications of pregnancy as a disability, as it too effectively prevents a woman from being able to work for a period of time. You can either experience partial or total disability depending on various factors, such as the nature of your illness or injury.
Fortunately, there is a type of insurance that can replace some or all of your lost income for up to a set period of time if you become unable to work. Your health or major medical insurance may cover your medical bills, but how will you pay the rent or mortgage and the utilities and car payments? Disability insurance is designed to protect you from this dilemma. It will pay you a set amount of money each month up to the term specified in the policy that you can use to pay your regular bills.
Long vs. Short-Term Disability Insurance
Disability insurance can be divided into two general categories: short and long term. Short-term disability insurance has a benefit period of up to two years. Long-term disability insurance can have a benefit period lasting for three, five or ten years or even until you retire in some cases. Most financial planners will tell you that carrying long-term disability coverage is more important than having short-term coverage.
This is because a long-term disability can be financially devastating for breadwinners and their dependents. However, you are much more likely to experience a short-term disability than a long-term one. Employers who offer disability insurance to their employees will typically offer both types of coverage, so that their employees are covered in either case.
How Short-Term Disability Insurance Works
Short-term disability income insurance is a fairly simple product. If you become unable to work due to a disability, then you simply notify either your HR department if you got your policy through your employer or the insurance agent or broker who sold you the policy. In most cases, you will have to provide evidence from your doctor outlining your disability and the length of time that your doctor estimates you will be disabled.
Make sure that you have the correct claim form and that you fill it out correctly. Then have your employer fill out their section of the form as well. Submit the form to your insurer and keep a copy for yourself. Then, after you have satisfied the waiting period (see below), you will begin receiving monthly payments from the insurer. The maximum benefit specified in the policy will be paid if you are totally disabled.
Both long and short-term disability insurance have a waiting period known as the elimination period that must be satisfied before they begin making payments. The elimination period essentially functions as a form of deductible, where you must cover the costs incurred from your disability out of your own pocket for a certain period of time before benefits begin.
While long-term disability coverage may not begin paying benefits until you have been disabled for at least two years, short-term disability coverage begins making payments much sooner. Some short-term policies even begin payments immediately, with no waiting period. The longer the waiting period, the lower the monthly premiums for the coverage will be. Therefore a policy that begins paying out immediately will cost considerably more than one with a 90 day waiting period.
Short-term disability insurance will usually replace anywhere from 40% to 80% of your earned income, and the typical elimination period with these policies is usually 90 days. The benefit period can be anywhere from zero to two years, with three to six months being the most common periods.
Conditions for Renewal
Short-term disability insurance policies can be subdivided into one of three groups. Non-cancelable policies guarantee that your premiums will never go up and the insurance company will never deny you coverage as long as you continue to pay the premiums. Guaranteed renewable short-term disability coverage guarantees you that the company will not make you take another medical exam when the time comes to renew your policy.
However, the company does have the option of raising its rates, provided that it does so to an entire group of insureds that share a common characteristic, such as age or occupation. Conditionally renewable disability insurance requires you to retake a medical exam for underwriting purposes every time the policy is renewed, and coverage will be denied if you do not meet the underwriting requirements. For this reason, it is best to stay away from conditionally renewable policies and purchase a policy that is both non-cancelable and guaranteed renewable.
The rules that govern the taxation of short-term disability plans are very simple. If you paid the premiums for the policy out of pocket and didn’t list them as deductions on your income tax return, then any benefits that the policy pays to you are tax-free. But if you did deduct them, or if your employer paid the premiums for you using pretax dollars, then the benefits will be taxed as ordinary income. This means that you will pay tax on the benefits at your top marginal tax rate.
Short-term disability insurance policies often come with a list of conditions under which the policy will not pay benefits. For example, the policy probably won’t pay you anything if you become disabled from engaging in a dangerous activity, such as mountain climbing or skydiving. And because all short-term disability policies require medical underwriting, you may be denied coverage if you have a pre-existing condition such as cancer or diabetes.
Alternatives to Short-Term Disability Insurance
If you don’t like the idea of having to shell out money every month for a short-term disability insurance policy, use that money instead to create an emergency savings fund. Many financial planners will tell you to do this, because if you can accumulate enough money to cover at least three to six months of your monthly expenses, then you probably won’t need the coverage anyway.
- Workers’ compensation can also cover you if you get injured while working on the job. However, 90% of all disabilities happen when the employee is not at work, so don’t count on this if you become disabled from something other than an occurrence at your job.
- Social Security Disability Income (SSDI) is long-term disability insurance, and it is very difficult to qualify for coverage as 55% of all applications are initially rejected. Furthermore, the average monthly benefit is only about $1100.
Some employers also require that you use up all of your sick time before filing a disability claim. They may also ask you to go in for regular medical checkups in order to monitor the amount of progress you’re making in your rehabilitation efforts. And you may be required to immediately notify your employer of any changes in your status.
Where Can I Buy Short-Term Disability Insurance?
There are several ways that you can obtain this form of coverage. The first place you should look is with your employer. They may offer group coverage that is cheaper than a standalone policy. In fact, most financial planners will tell you that short-term disability insurance is only economically feasible through group coverage, as standalone policies usually cost as much as standalone long-term disability policies. Short-term disability coverage can cost anywhere from $50 to $150 per month, depending upon whether it is a group or individual policy, the length of the elimination and benefit periods and the benefit amount that is provided.
You may also need to work for your employer for a certain period of time before you are eligible to take out this form of coverage. And in most cases, you have to work for your employer for at least 30 hours a week in order to be eligible. Five states, including California, New York, New Jersey, Hawaii and Rhode Island as well as Puerto Rico have mandatory requirements for employers to offer short-term disability insurance policies to their employees.
If your employer does not provide this form of coverage, then you can buy a standalone short-term disability policy from your insurance agent or broker. It will cost more than a group policy, but then you also don’t have to depend on your employer to provide it, and you will retain your coverage if you change employers. There are several major insurance companies that offer some form of short-term disability insurance, including Sun Life, Lincoln Financial, AXXA, Aflac, Mutual of Omaha, State Farm, Unum and Northwestern Mutual.
Short-term disability insurance can cover you if you become disabled for a relatively short period of time, such as six months. Payments can begin immediately or after two weeks in many cases, and this coverage can prevent you from having to deplete your savings or go into debt in order to cover your bills while you are unable to work. Consult your financial advisor or life insurance agent or broker for more information on this type of coverage and whether it is right for you.