Many people simply pass on disability insurance during their open enrollment period for company benefits. We tend to think that disabling events won’t happen to us. We won't get in a car crash, we won't have a heart attack, aneurysm, etc. It happens to other people, not us. We may even know someone struck with one of these life-altering events, yet we still cling to believing it won’t happen to us. Until recently, that is. Now, daily press briefings on the coronavirus have made getting deathly sick part of our daily thought process. And some people find themselves in dire financial straits due to their own or their partner’s illness. Depending upon the victim’s career or network of friends, there might be a benefit concert or a GoFundMe page, but that’s not typical.
A few years ago, I found myself going to the doctor and then another doctor and then calling my wife to tell her that I had been scheduled for an emergency procedure. Weeks later, I found myself having a much more significant procedure done and benefiting from a couple of disability checks through my employer's short-term disability insurance. I never thought it would happen to me.
Earlier in my career, I worked with someone who had an aneurysm while driving. Fortunately, the police pulled him over for driving erratically. Shortly after, he succumbed to the stroke. The company covered his salary but told the rest of us to buy disability income insurance.I was recently helping a federal employee evaluate her disability income protection needs. On the Federal Employee Education & Assistance Fund website, I found the article “What Happens If A Federal Employee Becomes Disabled And Can’t Work?” Greg Klingler from the Government Employees’ Benefit Association (GEBA) pointed out that “many people would find it difficult for their family to survive for an extended period of time on the … disability benefit of 40%—and remember, the 40% would then be taxed. Supplemental disability insurance can provide an employee a total of up to 67% of their pre-disability income, and the benefit provided by the insurance policy would be provided on an after-tax basis.”
You may be fortunate to have an employer that offers disability income protection insurance. If not, you can elect it during open enrollment (or you may want to elect additional disability insurance to supplement what your employer provides). There are two varieties, short-term (typically 90 days) and long-term. Long-term policies have a waiting period before your benefits kick in. Typically, that period is 90 days on employer policies. In an ideal situation, you would have a three-month cash reserve to stem the tide. If not, the short-term disability protection, which typically starts after 14 days, would pay until the long-term disability kicked in. It is important to understand how your policy defines disability, though. Your definition may not be the same as the insurance company’s. Usually workplace policies have a narrower definition of disability than private policies do. In fact, depending upon your occupation, through a private policy you may be able to elect more favorable terms.
Even if you have a policy through your company, it will not completely replace your income. Most workplace policies will replace about 60% before taxes for various lengths of time. Workplace policies are paid with income that has never been taxed, just like the money that goes into your 401(k) savings. That’s why the benefits from them are taxed, which is the point Klingler was highlighting in his comments quoted above. Because private policies are paid with money that has already been taxed, you receive the benefit tax-free. As I can attest, when you’re sick and disabled, your expenses rise. You need more medicine and have more doctors’ visits, more co-pays and coinsurance. Yet at the very time when you need more money, your income will be decreasing unless you have reserves to draw on This is where private disability income insurance would be helpful.
You may find it surprising that even a privately paid disability policy may only replace 62 to 70% of your income (without taxes being taken out, in this case). If you take your gross income and subtract federal taxes, Social Security and Medicare taxes, retirement savings, and other deductions, your net take-home pay is roughly 62 to 70% of your gross income. (Ideally, you have some cash reserves that could further supplement your income If you need more than that.) Insurers cap their benefits in this way so that their insurance is not more beneficial than you going back to work would be.
Private policies have many features to choose from. Different disability insurance carriers even target different job classifications. Medical professionals, for example would likely want to have a disability definition requiring the carrier to pay if they were unable to return to their medical specialty, such as obstetrics. That is known as own occupation. You can also choose to have a shorter or longer waiting period for benefits to kick in. There's usually a reduction in the monthly premium with a 90-day (or longer) waiting period; that is, these policies are often less expensive than the short-term ones. Of course, if you have both short- and long-term disability coverage, the former will bridge you for the 90 days until the latter begins. A strong cash reserve may also factor into your decision.
Whether you buy disability income protection or not, you need an income continuation plan should you become disabled. If you're the sole breadwinner, how would your family make it without you? If you're single, how would you make ends meet? An extended disability can deplete the mightiest storehouse of cash reserves.
Unfortunately, however, disability income protection is one of the most complicated protections around, so deciding to get it is only the first of a series of decisions you’ll have to make. There are a host of features to consider: cost-of-living benefits, catastrophic benefits, and residual disability, to name just a few. Evaluating your situation and various policy options is complex. You may want to enlist a fiduciary financial planner to help make sense of your options and provide guidance on the topic. Some fiduciary financial planners may also be licensed to sell insurance and may be able to help you implement the decision.
If the latter is true, however, once that fiduciary financial planner starts trying to sell you insurance, he or she is no longer a fiduciary and should be disclosing his or her conflicts of interest. You should also be under no obligation to implement an insurance plan with that individual. Instead, you should feel free to shop around, especially if he or she is employed by a captive carrier. A captive carrier means that the salesperson can sell only his or her employer’s products rather than showing you options from multiple carriers. A non-captive agent can show you options across carriers.
When building a financial house, you want to build it on a solid foundation. Securing your income, your cash flow, is the primary component of the foundation. If you don’t have a trust fund, your physical labor or intellectual capital generates the income you live on. You ensure your car and home, why not insure the income engine that makes those things possible?