Disability Insurance: A Primer
Have you ever considered how you would support yourself if you couldn’t work? Sure, there are programs like Social Security Disability Insurance, but they probably won’t provide you with the standard of living you want. Or maybe your savings are ample enough to allow you to survive. Either way, if you can’t work and don’t have an alternate means of supporting yourself, the probability of your quality-of-life decreasing is fairly high. Self-employed solo attorneys, or those who own small firms, are at even greater risk. When you’re the boss, the responsibility is on you to make payroll each pay period. On a personal level, many student loans don’t care if you can’t work. The good news is that there is a product which can help mitigate the risk associated with a loss in income. Disability insurance protects against the possibility that you’ll be unable to support yourself. In short, disability insurance pays you a portion of your previous income if you become disabled. Disability insurance is a fairly complex type of insurance, with several important factors which can drastically change the terms of the policy. It’s important for you to understand the basics so that you can find coverage that meets your needs.
Disability insurance can be obtained in several ways. It’s often a part of the benefit package offered by employers or it can be purchased through an insurance agent. No matter how the policy is obtained, there are four major pieces to consider when evaluating a policy. First, you need to know whether the policy covers short-term disability or long-term disability. This refers to how long the policy will pay benefits. The next is the elimination period. The elimination period is the amount of time after your injury that you must wait before your benefits kick in. The third piece to know is the percentage of income which your policy covers. Disability insurance will never cover all your current income; instead it covers a percentage, usually less than 50%. Finally, you need to know what definition of occupation the policy goes by. Under some policies you’re only considered disabled and eligible for disability payments if you can’t work in any capacity. Under other policies, you’re considered disabled if you are unable to work in your own field. There is a large difference between the two; mistaking one for the other could come to bite you later on.
The first thing to look at when considering a disability insurance policy is whether it covers short or long-term disability. Short term policies usually last from six months to a year and are often provided as an employment benefit. If you work for a larger firm, this is a common benefit. If you work for a small firm, any type of employer-provided disability insurance will be rare. One advantage to short term policies is that they have a short elimination period; they’re often referred to as first day accident, eighth day illness. While long term policies pay benefits for a longer period, they generally have a longer elimination period. The elimination period for long term disability policy is generally somewhere between six months and two years. Long term disability insurance is generally purchased on a personal basis, however occasionally, companies will offer it as a benefit. For companies who offer both short and long term disability insurance, it is customary for the elimination periods to overlap. For some it is possible to self-insure against the possibility of short term disability through the use of emergency funds or investment accounts. For others it is important to have some sort of short term disability insurance in order to protect themselves from the possibility of a losing their income.
Speaking of income; disability insurance will never cover the entirety of your income. The important thing to consider when comparing disability insurance is how much of your actual expenses the insurance will cover. You want to make sure that you’re buying coverage that will pay all your expenses during your disability. Generally, insurers will pay out up to two thirds of your total salary; they do this to keep down the incentive to take disability rather than work. Otherwise, insurers would be creating a moral hazard. Of course, you can buy insurance for an amount less than the maximum. It’s usually a pretty good idea to do so, if you can live on that amount. The less coverage you require, the less you’ll spend on that coverage. It’s usually smart to buy disability insurance early on in your career because the insurance will be cheaper, and you’ll establish your insurability. The problem with buying coverage early on in your career is that your income will likely rise as the years go by, effectively lowering the percentage of your expenses that the policy will cover. The solution to this problem is called a Future Purchase Option rider. This rider gives you the option to purchase a higher amount of coverage in the future without having to prove your health again. Another important option is a Cost of Living rider. This increases the value of the policy to keep pace with inflation, after the first year of disability. The best time to buy this rider is early on in your career when the possibility of a long period of disability is higher.
One of the most important things to consider when examining disability policies is how the policy defines disability. The strictest definition of disability is used by Social Security. This definition is known as any occupation, or any-occ. Social Security defines disability as the inability to engage in any substantial, gainful activity by reason of physical or mental impairment. For example, if a surgeon breaks his wrist and is no longer able to operate, it doesn’t matter according to any occupation. Since he can work at another occupation, any other occupation, he isn’t considered disabled. The most liberal definition of disability is known as own occupation, or own occ. Own occ means that you are considered disabled if you’re not able to take part in the principal duties of your own occupation. In the example above, the surgeon would be considered disabled under own occupation due to the fact that he wasn’t able to operate. Own occupation is generally only available for certain professionals. Own occupation is more expensive than the other definitions of disability, however the difference is worth it. Any occupation disability insurance is going to be a bad deal for most professionals. It’s better to invest in own occupation insurance if you feel that disability insurance is something which you need.
You want to make sure that your policy is both guaranteed renewable and non-callable. Guaranteed renewable means that you have the option to renew your policy at the same price going forward; the company can change the rates but only if they change the rates for your entire state or class. This is something that I highly recommend obtaining. Non-callable and guaranteed renewable means that your policy is locked in: the insurance company can’t change the specifics of your policy each year.
A few more notes on disability insurance: the first of which is to be aware of who pays the taxes on your disability insurance and how the benefits will be taxed in case of payout. Unlike life insurance, which pays out tax free, disability insurance payouts can be either taxed or tax free. The difference is whether or not the premiums were paid in pre-tax or post-tax dollars. For premiums paid with either pre-tax dollars or premiums which were paid by the employer and not recognized as income, the benefits paid out to you will be taxed as income. For policies in which the benefits will be taxed, it is often possible to obtain a higher level of coverage than a corresponding tax-free policy. In policies which the premiums were paid with after-tax dollars, the benefits paid to you will be tax free. Which is better depends on your personal situation; the difference usually isn’t large. The important thing is to base your planning around the correct amount of benefits; make sure that you have enough after-tax dollars to cover your needs if you decide to pay for your policy through pre-tax dollars. Another small point to consider is the difference between paying premiums monthly versus yearly. Many policies offer a discount of 5% to those who pay a single yearly premium. With a little bit of planning, this can be a substantial savings on what can be an expensive policy.
Finally, when you decide to buy disability insurance, find an insurance agent who specializes in disability insurance. The best candidate is someone who works for several companies and therefore can shop around to find the best policy to fit your needs. This is a highly specialized form of insurance; the best broker is one who deals with disability insurance specifically. If you can find one who specializes in working with your occupation and their specific needs relating to disability insurance then it’s that much better. Don’t leave something this important up to just anybody.