June 14, 2023

The Basics of Disability Insurance

Often overlooked and misunderstood, disability income insurance is one of the most vital components to a sound financial plan. Without the proper type and amount of disability insurance in place, even the best financial plans can be sent off track in the event of a disability. While most may have a general idea of their disability insurance plan through their employer, it’s important to have a full understanding of what that coverage offers and if there are any gaps in that plan. Here are a few frequently asked questions that are important to understand regarding disability insurance.


What is disability insurance?


Simply put, disability insurance is protection for a situation in which you are unable to work for an extended period of time. If there is an illness or injury, for example, and you were unable to work, then disability insurance is designed to kick in after a certain time period and begin paying you on a monthly basis.


That sounds important, but I have disability insurance through my employer. Will that suffice?


While some disability insurance is better than no disability insurance, it’s important to look at your personal financial situation and circumstances to make that determination. Oftentimes, simply workplace disability insurance is not sufficient to maintain one’s existing lifestyle.


The typical workplace disability insurance plan covers 60% of one’s base salary if you became disabled. Most benefits are employer paid, therefore any disability insurance payments to you would be taxable. For example, let’s assume a single income earner makes $200,000 of gross income, and then after taxes brings home a net of $10,000/month of income.


If the income earner becomes disabled and has no additional disability insurance outside of the workplace plan, he/she could expect 60% of pay (through the group plan).


60% x $200,000 = $120,000, but then this is taxed, which would end up netting approximately $7,000/month after taxes.


This is a $3,000/month decrease in net take home pay, which would most likely result in some sort of lifestyle sacrifice—be it monthly savings, investments, or lifestyle expenses. This is without mentioning the increase in medical bills corresponding with new circumstances.


An individually owned disability insurance policy is meant to help close that gap– supplementing income on top of any group plan and better allowing the family to sustain a similar lifestyle.


What’s the difference between short and long-term disability?


Short-term disability, generally speaking, pays as soon as a disability occurs and for a period of anywhere from three months to a year. More often than not, this is provided as an employee benefit. Long-term disability insurance only kicks in after a certain waiting period is fulfilled– generally 90 or 180 days. Payments generally last until age 65 or 67– depending on how the policy is structured.


How long will my disability insurance continue to pay out?


This important consideration is entirely dependent on what type of definition your disability insurance policy has written. The two most common definitions are as follows:


Any-Occupation– If a disability insurance policy holds this definition, the policy will only pay if you are unable to work in any occupation.


Own-Occupation– If a disability insurance policy holds this definition, the policy will pay if you’re unable to work in your own occupation or specialty (if you are a physician).


While this may seem as though it is a miniscule difference, the impacts from this definition change can be dramatic.


Let’s take an example of an oral surgeon who earns $500,000/year doing his normal physician duties. If he gets disabled and his policy is “own-occupation”, and ideally specialty specific, then he will receive disability insurance payments until he is able to go back to his normal duties as an oral surgeon.


Let’s assume the exact same scenario as above, only the definition of his policy is “any-occupation.” If he becomes disabled and the insurance company determines that he can do medical research earning $50,000/year, then the disability insurance policy will cease payments– as he can technically work in “any occupation.” This slight change in policy definition results in a massive swing in income replacement, and it is vital to ensure any individually owned policy is structured correctly from this standpoint.


Are there any limitations or conditions that would exclude disability insurance from paying out?


This will all depend on your specific policy– but generally speaking there are certain exclusions regarding foreign travel (some policies will not cover if you become disabled while out of the country) and mental disorders (most companies will limit benefits paid to two years– but some will pay to age 65). Additionally, any medical conditions at the time of disability insurance application will likely result in an exclusion being put on the policy. For example, if you have had shoulder surgery in the past, you obtain disability insurance and re-injure that same shoulder three years later, the exclusion could kick in and you will not receive disability insurance payments.


When should I consider buying disability insurance?


Similar to the life insurance application process, applying for individual disability insurance is entirely dependent on your age and health– meaning you must medically qualify through an underwriting process to obtain coverage. With that being said, generally speaking the younger and healthier you are, the better the chance of securing a cheaper disability insurance policy.


Securing the right amount and type of disability insurance is crucial to a sustained, protected long-term financial plan. Please consult with a trusted advisor to discuss if disability insurance is appropriate for your personal financial situation.




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