It’s time once again for a very important exciting insurance post! Yay, I’m glad you are as excited about this as I am, because today I am writing (and you will be reading) all about:
Yeah, I know, totally what you wanted to hear about today, more insurance talk. But trust me, you’ll want to read all the way through on this one.
I think most people have a decent idea of how the main types of insurance work. Health insurance helps you pay for doctor’s visits, medicine, and care for when you are ill or injured. Life insurance is meant to protect your loved ones and pays your beneficiaries when you pass away. Auto and Home insurance help pay for repairs to your home or vehicle when they are damaged or destroyed. The uses for these types of insurance seem reasonable and you probably have some of these types of insurance, especially where mandated, in the case of auto insurance, or home insurance if you have a mortgage.
I’d argue that disability insurance is just as important as these other types of insurance, but if you’re like most of the population you don’t have it and you haven’t really thought about buying any, unless you’ve already experienced a situation where you could have really used it.
Disability Insurance – The basics
At the most basic level a disability insurance policy will pay you if you become injured or too ill (disabled) to work.
How much money you receive, when, and for how long are all defined in the specific policy you purchase. As well as the types of illnesses and injuries that are covered.
One side note: disability insurance is different from worker’s compensation insurance. Worker’s comp will pay if you get hurt or injured in a work-related accident or injury. Disability provides insurance for when you are injured or ill and can’t work due to a personal accident like and auto accident, or long-term illness such as cancer.
Why Disability Insurance?
So, why should you consider disability insurance? With all types of insurance, it makes sense to understand the W questions first. What exactly does this insurance cover? Who is protected and who receives a benefit by having the insurance? Why should you specifically purchase it?
What: As we’ve discussed above, disability insurance pays you in the case you can’t work for an extended period of time due to an accident or illness.
Who: Typically, the person who owns the plan is the person covered and the one who receives the benefit from the insurance company if they can no longer work. This is different from life insurance where the insurance company pays your beneficiary when you die.
Why: This is the W question for which everyone’s answer is different. You need to ask yourself another series of questions or discuss them with a financial planner to understand if having disability insurance coverage is right for you.
What would happen to you or your family if you could no longer work for an extended period of time? Are you the sole income provider in your family, or would a spouse be able to provide if you could no longer work? Do you have enough money saved or are you close enough to retirement that you would be able to live comfortably if you had to quit working today?
The statistics on disability are pretty sobering, some estimates state that the average employee with a long-term disability or illness will miss 2.5 years of work. Another study found that of patients diagnosed with cancer, 42% depleted their life savings within 2 years. According to the Social Security Administration, almost 1 in 4 of today’s 20-year-olds will become disabled for a period of time before they reach the age of 67.
The Two Main Types of Disability Insurance: Long Term and Short Term
When it comes to the types of Disability Insurance it’s kind of like an old school sundae bar with two flavors, chocolate or vanilla, and a bunch of toppings you can sprinkle on top. The two flavors are long term and short term, and the toppings are the different riders that allow you to adjust the policies to best fit your situation.
The benefit period (how long you receive payments if you become disabled) for short term disability insurance can last anywhere from 90 days up to two years, while a long-term policy can last 5-10 years or longer. And most plans are designed to be in effect until you reach the age of 65.
Am I good if I have employer provided disability insurance?
Some of you out there may be wondering about disability insurance you receive as part of a group plan benefit from an employer. This is great because you at least have some coverage as a benefit of employment, but there are some questions to ask and things to look out for. The first is that since it is an employer benefit which your employer pays for and provides to you, any benefits you receive will be taxed. This differs from a policy that you pay for yourself where you would receive the benefits tax free.
If your company disability policy covers employees on their full monthly salary up to $5,000 per month, rather than receiving $5,000 dollars, you might receive around $4,000 depending on your tax rate. And that $4,000 might be enough to cover your expenses, but it pays to know that beforehand, so you aren’t relying on receiving the full $5,000 and coming up short.
Another wrinkle to investigate with employer provided plans is what occupations they cover. Most employer plans have “any occupation” coverage rather than “own occupation” coverage. This means that as soon as you are able to work in “any occupation” you may stop receiving your disability benefits, even if you are not well enough to go back to doing the work you were doing before.
As an example, if you were a surgeon that contracted a disease that caused hand tremors, you may be declared disabled to continue your current occupation, but the insurance company may decide that you are still able to work at another occupation where your disease would not affect your ability to do the job. If your disability coverage was “any occupation” then you could possibly be denied benefits since you could work in a job, even if it wasn’t the occupation you had before.
The key is to understand the benefits and limitations of your employer provided policy so you can back it up with a policy of your own if needed.
Key terms within Disability Insurance Policies
The type of disability coverage you receive can vary quite a lot based on your preferences and how it is designed. These terms are defined in all policies while the riders below are options you can include if they make sense.
Occupation Class: Insurance companies group professions into buckets based on incomes and how likely they are to make claims, similar to how they group individuals into segments based on your current health and habits for life insurance policies. The higher the occupation class, the more cost effective your disability coverage.
Elimination Period: This is the period of time before you are able to start taking benefits. It is usually 90 days for most long-term policies.
Benefit Period: How long you can retain coverage (typically till age 65) and how long you can receive benefits once you start (usually 5-10 years depending on the long-term policy).
Disability Plan Riders
There are many different riders that you can add to disability policies to adjust the terms and benefits you may receive. This is just a partial list, so make sure to do your homework on the riders available to you before purchasing a plan.
Future Increase Option (FIO): This can give you the ability to increase the benefit based on increased earnings, without undergoing another medical exam.
Catastrophic coverage (CAT): Long-term disability insurance will typically cover 60% of your salary, however with a catastrophic disability benefit rider you could receive up to 100% of your salary if you are unable to perform 2 or more functions of daily living (dressing, bathing yourself, etc), total and permanent loss of sight or hearing, or cognitive impairment.
Residual/Partial: Allows a partial benefit to be paid if you are not totally disabled but are in a situation where you lose 15%+ of prior year earnings.
Cost of Living Adjustments (COLA): Provides cost of living adjustments for claim payments to keep up with inflation.
Own Occupation: Can be considered totally disabled if you are unable to perform the duties of your occupation, even if you are employed in another occupation.
Retirement Protection Plans (RPP): You could receive contributions to your retirement plans in addition to the disability income benefit.
Student Loan Protection: Benefit would pay student loan payments as well as the disability income benefit.
Well, those are the basics on disability insurance, a less understood topic that I think more people should learn about so they can adequately protect themselves.If you would like some more guidance in this area I recommend seeking out a fee-only financial planner to help figure out if protecting yourself with long term disability insurance is the right decision for you. If you would like to talk to us at Steady Climb Financial Planning, give us a call. We are happy to help.