If you underestimate your risk of disability, you’re not alone … only 10% of individuals accurately estimate their chance of disability, according to a study by the Council for Disability Awareness. TMA Insurance Trust shares some startling statistics:
Short-term (“ST”) disability policies cover six months of disability or less. It’s typically better to build up cash reserves rather than pay a premium on a short-term disability policy. On the other hand, it is much more difficult to build enough cash reserves for a disability that lasts years. That is precisely why long-term (“LT”) disability insurance is a necessity.
Premiums on individual LT disability policies are usually higher for women than men, especially ones in their childbearing years, because the likelihood of disability is greater. Life insurance is the opposite: Men’s life insurance premiums are typically costlier than women’s premiums to account for a shorter male life expectancy.
How a policy defines the meaning of “disability” sharply impacts your ability to collect benefits. “Own occupation” and “any occupation” are the two primary categories of coverage.
Another thing to keep in mind is that not all own occupation policies are created equal:
Now, let’s delve deeper into disability insurance policies for three distinct groups of people: those covered by an employer group plan, self-employed people or those not covered through an employer, and stay-at-home parents.
Consider yourself lucky if you remain in this category. Typically, large employers offer short- and long-term disability policies at no cost to employees. While terms vary, benefits of 50% to 60% of pay are typical for an employer-provided LT disability policy. If you are not paying a premium on the disability policy, you will be taxed on the income you receive when collecting disability benefits.
I’ve noticed that government employees have different disability benefits than most employees of large companies. Short-term disability usually is not offered for government workers since sick pay should first be exhausted, and the level of LT disability benefits depends on the duration of the disability. The first year of disability is covered at 60%, but years 2 and beyond only offer 40% of pay. For this reason, I often recommend a supplemental policy for government employees.
If you do not feel comfortable with the level of coverage provided by your employer, you can shop around for a supplemental LT disability policy. The insurance carrier would take your current coverage in consideration to assure you do not make more money (after-tax) as a disabled person than if you were still on the job.
Work with an insurance broker who specializes in disability insurance and focuses on long-term coverage. Policies and carriers differ significantly, so gain a solid understanding from the broker about the nuances of the policy, also known as riders. Salary raises provide a higher probability of underinsurance, and therefore automatic benefit increases are helpful but more costly each year.
This group is vulnerable to having inadequate levels of disability coverage or simply not having it at all. I have been self-employed since 2014 and am fortunate to have disability insurance through two professional organizations. One organization offers life and disability insurance policies to all its members through Aon. Within the group policy, members individually select a 13-week or 26-week waiting period. Extended waiting periods lower the premiums you pay. Furthermore, members may individually elect coverage for partial disabilities. This type of policy is more expensive because it does not require someone to stay out of the workforce completely when disabled, and it falls under the true own-occupation definition of disability.
What if you are in a profession that does not offer group plans? You can buy an individual LT disability policy, but these policies are expensive — sometimes as high as 3% of income. Remember, you can control the duration of coverage. To help control costs, consider delaying the benefit commencement date and limiting the duration. For instance, if the 13-week waiting period with lifetime benefit is too expensive, investigate a policy with a 26-week waiting period and up to five years of benefits. Exercise caution with this strategy: You’ll need enough financial resources to support the first six months of your disability and any disability that extends beyond five years.
Presumably, you must have earnings to get disability coverage. Stay-at-home parents are not paid anything for their contribution to the household and typically would not qualify for disability coverage. Focus on maximizing the sole income earner’s disability insurance coverage instead.
Disability insurance is just one of the many topics that comprehensive financial planners like me discuss with clients. Fee-only fiduciary advisers sign a legal oath to act in their clients’ best interest and are solely compensated for advice, not products they sell. If you are concerned about your level of insurance coverage or simply want an independent viewpoint, I’d encourage you to consult a NAPFA adviser.