Insurance is just a part of modern life. We are all sure (or legally required) to insure our cars, homes, health, valuable items and even our life. What many of us don't think about insuring is arguably the most important of all; our income. It's our income that pays for not just all of the other insurances, but also funds our retirements & investments, rents and mortgages, and all other living expenses. So why would we not think that income should be insured?
Disability Income Insurance provides coverage when you become too sick or hurt to work. Statistics show that the possibility of disability is more likely than death at any age before 65 and, in addition, the costs of disability are typically greater than the costs of death. Statistics also show the following:
Every 4 seconds, someone is hurt in an accident at home.
Every 8 seconds, an employee becomes injured at work
Every 14 seconds, an individual sustains a disabling injury in an auto accident
So who needs disability income insurance? The obvious answer is anyone who earns an income should seriously consider disability income insurance. The less obvious answer is how much of your income you should insure and how to structure the policy. In the following sections I will address just that, and more.
Short-Term vs Long-Term Disability Coverage
What's the difference between short-term and long-term disability coverage and which one do I need? This is a very common first question when beginning your research. Short-term disability is designed to pay out over a short time period, 12 months or less, and typically has an immediate benefit after getting injured or sick (some may have a waiting period, but many don't). As short-term disability is often provided through employer provided policies, your first step should be to check if your employer provides this benefit or not. More often than not the cost vs benefit of owning an individual short-term disability policy does not pencil out. It is common to either have this covered through your employer's short-term disability group policy or to simply supplement this with a 3 to 6 month emergency fund.
Long-term disability coverage, on the other hand, does often make good financial sense to fit into your overall financial plan. These policies are designed to replace lost income over a long period of time, often until age 65, but require the insured to wait through an elimination period, also known as a waiting period, before benefits can begin. Typically, the elimination period is anywhere from 90-180 days, but can vary between 60-365 days. There are a number of employer's who offer this type of coverage as well but it is less common that that of group short-term disability coverage.
Benefits of Long-Term Disability Income Insurance
If your employer either does not offer long-term disability coverage or only offers partial coverage, it is worth taking a deeper look into an individual long-term disability policy. Individual policies will typically cost somewhere between 1% - 4% of your gross income, mostly depending on job type, policy design and age. Individual policies will provide tax-free benefits, which means when you begin receiving payouts, these come to you tax-free. Unfortunately, employer provided long-term disability benefits do not receive this same tax treatment and payouts from employer provided plans are taxed as income.
With the proper riders and policy design, disability policies can cover much more than just total disability from sickness or injury. Many policies offer coverage for partial disability which is often overlooked as a benefit, but in real-life circumstances can be a substantial benefit. Many injuries or sicknesses can lead to partial disabilities, which often leave someone only receiving partial paychecks and lead to some painful long-term financial issues. Partial disability coverage will then supplement the partial loss in pay due to long-term reduction in job responsibilities. Other riders and coverages available can insure retirement funding (both employee and employer funding), catastrophic incidents, and provide inflation protection on benefits received. This is not an exhaustive list of benefits, but just a sample of what riders and benefits are out there.
Coverage Needs and When to Start
There is no one-size fits all answer to the question of how much coverage you need, but in general, you will want as much coverage as you can get and afford. Often, these policies won't cover more than 60-70% of your total income so that tends to be a reasonable goal. Again, with this level of coverage and paying out-of-pocket for an individual policy, you can expect this to cost anywhere from 1% - 4% of your gross salary. However, if for some reason your policy costs more than this and is unaffordable, you can bring your coverage level down and tweak some other aspects of the policy design to make the policy more affordable. It is always better to have some coverage than none, especially in the event you actually do face a total or partial disability event.
The best time to get coverage in place, as with life insurance, is as soon as possible. We can never predict with certainty when a life event may happen that will make us uninsurable. Better to lock in coverage now than risk waiting until the mythical "perfect time", which only puts you at risk of becoming uninsurable and never being able to get coverage in place. Also, as with life insurance, the younger and healthier you are, the cheaper the premiums will be for your disability policy. Again, I understand there can be barriers to starting a policy, but in general, it is always best to get coverage in place as soon as you can.
Own Occupation vs Any Occupation
These are terms used in the Disability Insurance world which describe whether the policy will cover you when you can't work only your current job (Own Occupation) or will only cover you when you can't work any job. To elaborate, when you become disabled and have Own Occupation coverage, you will receive benefits if you are unable to perform the necessary functions to work your current job. This does mean that, if you are able to perform the functions of a different job and not your current job, you can still work and earn an income will receiving disability benefits. This is not true with an Any Occupation policy. These policies only pay out when the insured is unable to work any job. As the goal with disability income insurance is to protect future earnings potential, it is generally best to find a provider who offers Own Occupation coverage as this will ensure you are truly covering your future earnings potential, and not just any future earnings potential.
To conclude this post, I will leave you with some interesting and meaningful disability statistics:
Approximately one in four people will experience a disability condition that inhibits their ability to work before they retire.
Over 50 million Americans do not have additional disability income coverage other than that provided through Social Security.
68% of American employees live from paycheck to paycheck, with no emergency fund to weather the financial storm a disability could cause.
The average monthly benefit paid by Social Security Disability Insurance (SSDI) in 2020 was only $1,277.