Part I: What is disability insurance and why is it so important?
Disability insurance is one of the most important insurances you can buy to protect your financial picture.
But why exactly is that?
To get a better understanding, let’s think about your financial assets and the things that you would insure. First, let’s think about protecting the most important assets. What would you say is your most important asset? The immediate and most common answer for most people is their home. The reasoning is simple, it is because homes are often the biggest individual assets on many people’s balance sheets.
If you answered the question above with your home or another physical asset, then you will want to pay close attention and keep reading.
There are a few different types of assets (and considerations) that people do not immediately consider when they are thinking about their assets. Notably, your health and your ability to earn a steady income as a result of good health. This makes your other assets like your home, vehicles, savings, and investments quite pale in comparison.
Your health is what enables you to earn a good income. Your income then funds your home, vehicles, savings, and investments. So really, all of your future financial plans are dependent on your ability to earn an income.
Here is another question for you. Would you rather currently have tons of money with poor health, or great health with no money at all? If you have good health, you can earn income. If you don’t have good health and can’t earn an income, you will quickly lose other things that are important to you. Personally, I would make the argument that life becomes much less enjoyable if you lose your health.
Being sick and broke would rank high on many peoples worst-case scenario lists. There are many things you can do to help your health such as exercise and eating healthy. With that being said your health isn’t completely within your control. Accidents and diseases can and do happen. While you can’t fully protect against losing your health, you can protect against losing your income.
What would happen to you if you were to get sick, lose your health, and no longer be able to earn money? This is where disability insurance comes in.
Disability insurance is designed to provide income and help pay your bills if you lose your health. Disability insurance plays an under-utilized and extremely important role in your financial plan because of the risk it mitigates and protection it provides.
What is the value of your total income potential? Below is a very simple calculation of how important earning an income is.
Let’s say a 40-year old man makes $65,000 per year, plans to retire at age 65, and will get a 3% raise each year. The total value of income over the next 25 years equals $2,505,947.
As you can see from the example above, your income has a big impact on your life over a large span of years. Your income potential is worth millions of dollars. How much is that worth to protect and are you willing to protect it?
Another reason why disability insurance is so important is because of the risk and probability of becoming disabled. You have a higher probability of becoming disabled at an early age than you do at dying at an early age. Your odds of becoming disabled before you retire are around 1 in 3.
The leading causes of disability include (but are not limited) to the following:
- Back pain
- Heart disease
It is important to protect yourself against this risk of becoming disabled as this would result in devastation for your financial plan and overall financial well-being.
Monthly disability premiums can sometimes be challenging for young working professionals making ends meet and providing for their family. However, for most people, it is well worth the cost to know that your income and financial means are being protected at all costs.
Part II: Who needs disability insurance?
By now, you likely have a good idea of how disability insurance works and why it’s so critical to consider this type of insurance. It goes without saying that you likely also have a lot of questions. And rightfully so.
Who doesn’t need disability insurance? Those who are financially independent or close to financial independence won’t necessarily need disability insurance coverage. What I mean by financial independence is those who don’t need to earn an income any longer because of the investment and passive income they have built. The money they have and earn in passive income could last them for the rest of their life.
Who should especially consider disability insurance? Those who have worked to build a high income for themselves and those who have dependents counting on their income should seriously consider disability insurance. Really, anyone who is earning an income they depend on as a means of survival should be considering disability insurance.
Part III: Understanding disability insurance policy details
It is tough to compare different disability policies among the different providers because there is such a variation of products. Finding a good, independent disability insurance agent who isn’t beholden to any particular insurance company can help you secure the right policy at the right price for your specific situation.
Here are the major things you need to consider when you are shopping for an individual disability insurance policy:
Short-term vs Long-term disability
A short-term disability insurance policy will pay you a monthly income, if you become disabled for a short period of time. If you become disabled for a long time it will only pay you in the beginning. Short term disability policies start paying benefits a week or a few weeks after becoming disabled up to three months. Although payouts could potentially last up to two years depending on the policy length.
The total benefit that you get from a short-term disability policy is relatively small, however the likelihood of you using it at some point, is relatively high. Because the total benefit payout is relatively low, your premium costs will also be relatively low. But because the likelihood of you using it is higher, the premium is relatively high compared to the total benefit you may receive.
A short-term disability policy becomes a good option when individuals don’t have an emergency fund built up and when they work in a career such as construction where short term, physical injuries are more common.
Another common use for short-term disability is during pregnancy and child delivery. As a result, many employers offer short-term disability as a benefit that you can choose to get.
In contrast, a long-term disability insurance policy will pay you a monthly income if you become disabled over a long period of time. Long-term disability payouts typically last anywhere from 3 months being paid out until age 65 or age 70. However, there are different policies with different benefit payout lengths.
While a long-term disability has a lower likelihood of occurring, the impact is significantly bigger. This impact has a high total possible benefit payout. The total value of the policy payout would be high but the likelihood of collecting it is low because becoming disabled for a longer period of time is low. The premium price is low compared to the maximum benefit you are eligible to receive and compared to the significance of becoming disabled and losing your income for the long term.
The impact of becoming disabled for a short period of time versus for a long period of time is drastic. If you have an adequate emergency fund, in most cases you can sustain missing a few weeks or even months of work due to a disability. If that duration of time gets extended to longer periods of time, that is when a disability can become debilitating to your financial situation. This is why having disability insurance, especially long-term disability insurance, is critical.
How long will you receive disability benefits from the policy? The benefit period is how long you will continue receiving benefits for.
The longer the benefit period, the higher the premium cost. The shorter the benefit period, the lower the premium cost. This is because of the total potential benefit payout from the policy.
Generally, it’s good practice to go with the longest benefit period possible that you can afford or the shortest period necessary. Many long term policies have benefit periods until age 65 or 70, however some have shorter terms such as 5 or 10 year terms.
The elimination period is how long the disability needs to last for before you are able to claim the disability and before the policy starts paying out a monthly benefit.
The shorter the elimination period, the higher the premium cost. The longer the elimination period, the lower the premium cost. An elimination period of 60 to 180 days is common with long-term disability policies. Essentially this means that you would need to have the diagnosed disability for at least a duration of 60-180 days before you are able to receive any payouts.
Something important to keep in mind is that the larger emergency fund (savings) you have built up, the longer elimination period you can afford to have. This will result in a lower premium cost.
A three month elimination period is typically the most common with long-term disability insurance policies.
Before signing any sort of disability insurance policy, it’s important to familiarize yourself with the below provisions.
Non-cancelable means the insurance provider does not have a right to change the pricing of the insurance policy. If this provision is not in place, then the provider has the ability to change the premium you pay on a class basis. An example of this would be increasing the premium for all males between the age of 30 and 35 in the state of Arizona. When you have a policy that is non-cancelable it means the premiums are locked in at the same price. Non-cancelable policies are normally more expensive than guaranteed-renewable policies.
Guaranteed-Renewable means that as long as you pay the premiums for the disability insurance policy, the insurance provider cannot take the insurance policy away from you for any reason. However, they can increase the premium you pay on a class basis.
Conditional Renewal means that the contract benefits will be the same until a future event, such as turning age 65. This means the benefits can’t be changed until the future event, only at that time, can they change the policy benefits. An example of this would be reducing the payout benefit period to two years once you turn 65 years of age.
Part IV: Additional considerations with your policy
While the above policy details and considerations are a good place to start, it’s important to know that your homework doesn’t quite end there.
Here are additional considerations that you will want to review before securing your policy:
Monthly disability benefit amount
Another really important consideration is the monthly benefit amount that you would need if you became disabled. As you decide on how much benefit you will settle on, you will want to consider the following:
- Monthly expenses: How much disability income will you need to properly cover your monthly expenses? To answer this, review your current monthly expenses and estimate what amount you would be able to live on if necessary.
- Tax-free benefit: If you have an individual insurance policy, your monthly benefit is often tax-free. However, group insurance policies often require paying tax on your benefit which results in a lower monthly payout.
- Percent or flat dollar amount: Disability policies often cover a percentage of your current income or a flat dollar amount. This depends on how the policies are structured. For long-term disability policies, 60 percent of your income is common for the amount of coverage.
Policy definitions of a disability
Despite what you might have heard or thought, there are actually several definitions of what entails a ‘disability’ for the purposes of insurance. It’s important to you get a very clear understanding and consider these definitions before signing anything:
- Any Occupation: Considered disabled if the insured individual cannot perform the duties of “any occupation”. As you might have guessed, this means any job that exists. This definition of disability provides for the least expensive premium as the likelihood of becoming disabled by this definition is extremely low.
- Modified Any Occupation: Considered disabled if the insured individual is unable to perform duties of a gainful occupation they’re reasonably fitted by education, experience, training, and prior economic status.
- Own Occupation: Considered disabled if the insured individual cannot perform the duties of his or her “Own Occupation”. By definition, this means specifically for your current occupation. These policies are often more expensive and are ideal for specialized, high paying fields.
- Split Definition: Begins with ‘own occupation’ and moves into ‘modified any occupation’ after a year or two under the own occupation definition.
It is important to understand your policy’s definition of disability because this will help you to understand your level of protection and when it will apply.
Most long-term disability insurance policies will exclude certain types of conditions from coverage. For example, mental health conditions are often not covered or are subject to a shorter benefit period.
These exclusions typically only last for a period of time, such as the first two years of the policy being in place. However, sometimes they can last for the full duration of the policy. You should evaluate any types of exclusions when taking into consideration your disability policy.
This will provide partial benefits if you go back to work but aren’t making the same wage compared to before your disability. In these circumstances, the residual benefit will make up the difference. Some policies come with a residual benefits rider and others don’t. Do your research to determine if your policy is or will be equipped with one.
Policies with this rider will increase your monthly benefit each year to keep up with inflation. This effectively makes it so your buying power stays the same. Some policies have limited COLA time periods or percentage increases. Just like any of the other considerations, it is important to read the fine print because $5,000 in the distant future will not buy $5,000 worth of goods today.
Future purchase option
This guarantees you the right to increase your coverage in the future if your income increases without any medical underwriting. This is a valuable benefit because it eliminates the risk that a decline in health could prevent you from getting more coverage when you need it.
Insurer’s financial rating and reviews
It is important to make sure that the insurer is in good financial condition. You can look up an insurer’s rating through any of the following companies: A.M. Best, Fitch Ratings, Moody’s, and Standard & Poor’s. When it comes to protecting your income, you will want to make sure you are in good hands.
Part V: Individual vs. Group Disability Insurance
One of the largest debates and considerations around disability insurance policies is whether you should go for an individual policy or just use a group policy.
Both come with pros and cons. Deciding which one is the better fit for your financial plan and security can oftentimes be subjective.
To make it easier, we’ve compiled the pros and con in the tables below:
Group disability insurance
|Cost: The cost of group disability policies can often be cheaper compared to individual plans.||Taxation: Most of the time with group policies the benefits are taxed. This results in less monthly benefit(s) in your pocket.|
|Access: Group disability insurance policies are often easy to get.||Lack of control: You often can’t design your policy to fit your individual needs.|
|Health: There is typically no medical underwriting required.||Limits: Coverage amounts may be limited.|
|Portability: You can’t take a group policy with you. If you change or lose your job, you typically lose your coverage.|
Individual disability insurance
|Portability: If you change jobs or lose your job, your coverage is still in place as long as you make your premium payments.||Cost: Individual policies are typically more expensive on average. However, a lot of people in the early career stages can expect to pay between $150 and $250 per month for coverage.|
|Customization: With individual policies, you can customize the policy to meet your individual needs. You can pick and choose between the policy features to best meet your needs.||Complexity: Disability insurance is complex and it can be hard to compare policies from different insurers. This is why it is especially important to find an independent insurance agent who can walk you through the pros and cons.|
|Tax-free benefits: Your benefits will be tax-free because your individual disability policy will be paid for with after-tax dollars. This results in getting a larger monthly payout.||Medical Underwriting: Individual policies require medical underwriting, this includes an exam and extensive questions.|
Part VI: How and where can I get disability insurance?
There are a number of financial service providers, insurance providers, or insurance brokers that you could use to get disability coverage in place to protect for current and future income.
Savology works with several top-rated, quality financial providers that make it easier for you to get the right services for your financial plan. This of course, includes disability insurance policies that you can rely on for sufficient income protection.
One of those companies we highly recommend is Policygenius because of their marketplace style approach to insurance to help you find the best rates. You can get a free disability insurance quote in just a few minutes here.
Alternatively, you could contact your current agent or broker to see if they offer disability policies. In general, it is helpful to get 2-3 quotes from different providers before making any final decisions on your policy.
Part VII: Things you need to avoid when considering disability insurance
As you start doing your research and compiling a list of considerations for your disability insurance policy, there are several things that you need to be aware of. By avoiding the following you will be setting yourself up to make a much better decision when it comes time:
Stop thinking that you are invincible
The stark reality is that people are more prone to getting a disability than you think. The risk of either a short-term or long-term disability staggering. You need to be proactive and take the necessary measures to protect your income and your financial plan.
Don’t settle on the first quote that you get
Just like any other type of insurance or financial service, it’s critical that you take the time you need to conduct proper research. Now that you are well-equipped with the important features and considerations of disability policies, make sure you are using that information when seeking policies. Use this understanding to get comparable quotes from multiple providers to help you make the best-informed decision.
Don’t rely on Social Security disability coverage
Social Security disability coverage is not easy to qualify for. You have to be considered disabled for at least one year and you have to have been in the workforce for a certain period of time. Additionally, this type of benefit only pays out to the most serious disabilities. It is not something that you should rely on to protect your income.
Moving forward with disability insurance
Your income and your ability to earn an income are arguably your biggest financial assets. That is why protecting yourself and your income is absolutely necessary. Knowing that even in the worst case scenario your family will be provided for is one of the immediate benefits you can gain with a disability insurance policy.
While you can go find any provider to get disability insurance, Savology has vetted top-rated, quality financial providers like Policygenius to make it easier for you to get the right services to fit your financial plan.
Your financial future starts today
Savology has helped tens of thousands of households across the United States improve their financial well-being by providing comprehensive digital financial planning. Users can get started with our free financial planning or premium monthly planning memberships, allowing them to build a personalized financial plan, holistic report card, personalized action items, and more. In addition to our consumer-facing platform, we’re helping employers across the country provide their employees with effective financial wellness benefits.