Do You Need Disability Insurance?

Ask any financial planner or insurance agent what risk people usually forget about and the answer will probably be disability. Their clients often come in the door questioning whether they have too little, too much or the right kind of life insurance, but rarely have they thought about how they could survive financially with no earned income. In fact, disability insurance is as important as—and in some cases, even more important than—life insurance.

At any given age, the odds of becoming disabled are much higher than the odds of dying. Every year, 12% of the adult US population suffers a long-term disability. One out of every seven workers will suffer a five-year or longer period of disability before age 65. If you’re 35 now, your chances of experiencing a three-month or longer disability before you reach age 65 are 50%, according to the National Association of Insurance Commissioners (NAIC). If you’re 45, the figure is 44%.

These odds would not be a problem if people had substantial savings that could be drawn on in the event of a disability. But that’s rarely the case, and any money that has been set aside has likely been earmarked for goals such as college or retirement. In a recent survey, 56% of adults said they would be unable to meet their expenses if they couldn’t work for a year.

First, suffering a disability would be a catastrophic event for you, your family and your friends. It would create enormous emotional pressures for your family because your role would change and you would have physical needs to be met. There would be enormous financial pressures that would exacerbate those emotional pressures.

To complicate matters, few employers offer disability insurance and it’s much harder to qualify for individual disability coverage than for individual life insurance. The bottom line is that if you’re working and you need your income to continue after you suffer a disability, you need disability insurance.

When you apply for disability insurance, the insurance company will tell you if you have too much money to qualify for coverage. That’s because, unlike life insurance, you can’t buy all the disability insurance you may need. Usually, you can get a maximum of 60% of your monthly earned income before taxes. Unearned or investment income does not qualify because it presumably continues even if you are disabled. This limit is in place so as not to deter people from returning to work.

Social Security Disability Coverage

If you are working, you may already have some disability insurance. Social Security provides disability income as well as retirement income. However, it’s very difficult to qualify for the disability benefits of Social Security. More than 80% of the applicants fail the first time around. Some hire lawyers to help in the appeals process.

You can get an estimate of your Social Security disability benefits online. The average benefit is only $1,130 a month. Just as with retirement benefits, your disability income is dependent upon your covered earnings, or the amount on which you are taxed for Social Security. Because they’re so hard to come by, don’t count on the benefits when you evaluate your disability income needs.

Workers’ Compensation

The second kind of disability insurance you may already have is workers’ compensation. Many employers are required to provide this coverage, although the amount and duration of monthly benefits varies by state. Workers compensation comes into play if your disability is job-related. Payments typically last for a few years and tend to be low. As with Social Security disability payments, it’s wise to think of workers’ compensation as added assistance if you qualify, but don’t count on it.

The most common kind of disability insurance, group plans, are typically offered through your employer. If your employer doesn’t offer a group plan or you don’t like what you’re offered at the office, you can shop around as an individual. But keep in mind that, without a group, your price is based on your unique situation and needs. Like health insurance, that means individual plans are generally cheaper if you’re young and healthy and costly if you’re old with heart trouble. Even so, shopping as an individual opens a wealth of options—such as coverage for lost bonus income above your salary, or portability to keep the disability coverage even if you change jobs. If you have unique needs and are willing to shop around, an individual plan is worth pursuing.

If you have a basic employer-sponsored disability plan or if you’re content to rely on Social Security for any long-term disability claim, then supplemental disability coverage is a decent and affordable bridge. As the name implies, it is an additional layer of coverage to help pay for medical or living expenses that may not be covered by a long-term plan. For instance, if you have an employer-sponsored group plan that pays just 60% of your paycheck, for a modest monthly fee you may be able to add on a supplemental policy to bring that amount up to 80%.

The bottom line is that, with any financial product, your personal needs will dictate what kind of coverage is best for you. Most reputable insurers offer policies that cannot be canceled and are automatically renewed as long as you pay your premium on time. But obviously, you should always check for this language because it is crucial to any good disability insurance.

The amount of time you have to wait for your first disability check and the maximum length of benefits is also important to know. Not only does it dictate terms of your reimbursement, but these periods also dictate price. For instance, if you have enough sick time and savings to wait 120 days before your first disability check, you will pay a lower rate than someone who can manage only 60 days before their first payout. Like choosing a larger deductible on your car insurance, extending your waiting period can save you a bundle on premiums.

Disability insurance labeled “own occupation” applies to your current occupation and the ability to perform it. This is crucial to know because cheaper forms of disability insurance may require you to take any job you are physically able to perform—even if it pays a fraction of your former pay or forces you to take a step back in your career.

For a slightly higher rate, a policy with a future purchase option allows you to increase coverage as your wages rise—without taking another physical or rewriting the whole policy. This flexible option to a disability policy is useful to those who are climbing the corporate ladder or change jobs frequently.

If you own your own business or incur significant business expenses that don’t come out of your regular paycheck, you may want to insure against overhead charges as well as lost income. Without this kind of policy you may see your paycheck protected but lose your business as office with rent, utilities or other expenses pile up. Typically, anything that is tax deductible under business expenses will be covered by overhead insurance.

If you’re disabled for five years or more, it may be difficult to keep up with the bills if your payout is fixed but your expenses keep rising. Check any long-term plan to see whether payments are indexed to inflation in the event of a claim.