Disability Insurance: Understanding the Basics
Many times, we think about what would happen to our family if something happened to us (and our earning power) and we weren’t around to support them. This worse case scenario of leaving a family that depended on us behind makes the decision to purchase life insurance motivating to make sure they are cared for. But what if something happens to us where our earning power is impacted and we cannot provide for the family anymore, yet we continue our lives? This is a far more common situation than death, with disability four times more common than death at age 30, and twice as common than death at age 45. This is where disability insurance fills an important role in family risk management. Below we will touch on some of the basics:
Different classes of insurance, what to be aware of:
There are three main classes of disability insurance:
- Own Occupation (most expensive), where you qualify and are compensated for your specific occupation’s criteria needed to do the job. A classic example is a brain surgeon who develops a tremor in their hand and can no longer operate. The insurance would cover this despite the surgeon being of sound mind and body otherwise.
- Any Occupation (least expensive), where you qualify based on being unable to perform an occupation based on their education, qualifications, or experience. If the surgeon above had one of these policies, they would be expected to get a job doing something related in the medical field such as a doctor that doesn’t practice surgery, even though the pay may go down. If this same surgeon had a head injury in a car accident that caused a loss of memory, then they would likely qualify for this coverage under an Any Occupation policy.
- Split Definition, offered by group policies, will often cover an employee for a specific period like two years, but then switches to an any occupation definition. In this case, the surgeon would be expected to retrain over the two years for an occupation that can provide a livelihood. This would not be ideal but would provide a path forward. This also lowers the premiums for the employer.
An important feature of any policy is the elimination period, or the time that you are disabled before benefits kick in. A common elimination period is 90 days, so you would either want an emergency fund or short-term disability insurance to cover this period. The longer an elimination period, the lower the premiums so this is a time-deductible of sorts. If you have group coverage, it is important to know if benefits are offset by Social Security Disability. A policy that would normally pay $3,000/month may only pay $1,000/month if you qualify for $2,000 of disability from Social Security.
Where and how do I get Disability Insurance?
Disability Insurance is primarily available through two sources, group policies offered through your employer, and privately where you purchase them yourself. Sometimes you can purchase additional coverage through the group policy. If this is the case, one would want to determine if the policy is portable if you left the employer. Ideally you would want at least 60-70% of your salary to be paid out by one of these policies. If your employer doesn’t offer this, then private disability insurance is a good replacement or supplement. The advantages of private disability insurance are as follows:
- Portability, you can take them from one employer to the next. If you change professions to a more hazardous profession, you may have a premium increase or be excluded altogether, which is important to be aware of.
- You can often collect the benefits of one of these policies and Social Security disability (if eligible) as well, leading to greater income while disabled.
- If you pay the premium on the policy and not your employer, the benefits are not taxable, meaning you need less benefit since you no longer must pay taxes on them. Conversely, if you have a group policy whose premium is paid by the employer, you will have to pay taxes on the benefit. An example would be a group policy where the employer paid 70% of the premium and the employee supplemented the policy with 30% of the total cost. In this case, 70% of the benefit paid out would be taxable.
It is important to understand how a disability to wage earner(s) would affect a family’s finances in the near (maybe helping the kids through college) and distant future (think retirement). A financial planner can help you determine what coverage you need to realize your financial goals in the event of a disability. For more information on how we can help, please schedule a free consultation at https://go.oncehub.com/f5fp.
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