It would be difficult to find a breadwinner in any family who doesn’t understand the importance of life insurance in providing protection for those dependent on their income in the event of their passing. Likewise, most of us wouldn’t even consider buying a home without properly insuring the house against disaster or mishap (and our mortgage lenders wouldn’t let us do it, anyway). And what about health insurance? A good plan that covers the costs of hospitalization or even prescription drugs is one of the most valuable benefits any employer can offer.
But there is one major gap in most financial plans that Americans should be insuring, but aren’t: their ability to work and earn income. Although disability insurance is an efficient way to fill this gap, it is one of the most under-utilized products in the marketplace: about a third of American workers don’t have any form of disability coverage, according to the nonprofit Council for Disability Awareness.
The fact is that for workers or employees of any age, some form of disability is much more likely than death. According to the Social Security Administration, the average American is 3.5 to 4 times more likely to experience disability than death before normal retirement age. They estimate, for example, that over 25% of today’s twenty-somethings will have a disabling injury or illness before reaching retirement.
It’s important to remember that, unless you are injured on the job, worker’s compensation insurance won’t cover your loss of income. If you get sick or are injured outside your line of work, you have four ways to continue some or all of your income: paid sick leave, accrued vacation time, your emergency fund, and disability compensation in some form. Even if you are very healthy and have previously taken little sick leave, it is unlikely that you can accumulate more than a couple of months’ worth of paid time off for illness or non-work-related injury. For most employees, accrued vacation time will cover no more than an additional month, at most. So, that leaves some form of extended disability coverage as your only means of continuing your income until you are able to return to work. And by the way, even if you qualify for Social Security Disability Income (SSDI), it will take at least five months for the benefits to begin. Can you cover that entire timespan from your current resources? If not, it may be time to take a closer look at disability insurance.
Like almost any life- or health-related product, disability insurance is less expensive when you are young and healthy. And like most insurance products, disability policies come with various options and types of coverage that directly affect the premiums you must pay. Let’s look at a few of the most important variables.
Pre-disability income. This is where the policy defines the amount of income being covered. Pre-disability income generally only includes salary or wage income. So, for executives whose compensation may come in various non-salary forms such as equity compensation or bonuses, the disability benefit will typically be based only on the salary portion.
“Own occupation” vs. “any occupation.” Disability policies may provide for income to be paid upon the owner’s inability to do the same kind of work they were doing before the disability (own occupation), or upon their inability to do any kind of work (any occupation). In most cases, it is best to have “own occupation” coverage. It’s important to understand how “disability” is defined in a typical “own-occupation” policy. Generally, the policy will define it as “inability to perform the material and substantial duties of your occupation, even if you are gainfully employed in another occupation.” That last phrase is key. For example, suppose a practicing surgeon receives an injury to her hand that renders her unable to continue to perform surgical procedures. Under an own-occupation policy, she would be considered disabled and would receive benefits even though she might choose to practice medicine in some other capacity—as a family practitioner, for example. This flexibility is very important in many cases.
Elimination period. This is the amount of time you must be disabled before the policy begins paying benefits. It can range from 30 days (more expensive) to two years (less expensive), but most policyowners choose a 90-day elimination period and use paid sick leave or other sources to cover the initial waiting period.
Benefit period. This is the length of time during which benefits are payable under the policy. This can range from one year (least expensive) to the insured’s age 65 (most expensive).
Coordination with SSDI. As mentioned above, some disabled persons may become eligible to receive disability benefits through Social Security after at least five months of disability. Many policies contain provisions for coordinating benefits with SSDI as those benefits become available. It is important to review the policy terms carefully in order to understand how the benefits may change under these circumstances.
Taxation. Depending on whether the policy is funded with pre-tax dollars (available in some employer-sponsored plans), the benefits may be taxable income when they are received. If premiums are being paid with after-tax dollars, benefits are generally not taxable.
At Mathis Wealth Management, our goal is to help our clients construct a financial plan that allows for as many of the “what-ifs” as possible. In other words, the best surprise in your financial plan is probably no surprises at all. To learn more about how we can utilize disability insurance and other insurance products to help safeguard your financial future, click here.