Self-employed disability insurance

Being your own boss comes with plenty of perks, but a cushy benefits package from corporate isn't one of them.
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10 mins

If you’re a self-employed business owner, you have two major reasons to invest in disability insurance.

  1. First, an injury or illness can prevent you from earning an income from your business activities.
  2. Second, you may need insurance benefits to keep your business afloat while your recover from your disability.

In this article, we'll walk you through everything you need to know about disability insurance for self-employed workers including:

Read on to learn more.

Choosing features in your disability insurance policy

Self-employed workers will find the process of buying an individual disability policy similar to that used by employees.

If you are self-employed, you will need to consider whether you need short term coverage, long term coverage, or both.

Short term disability insurance is typically for temporary, less serious injuries that limit the ability to work, but that people generally recover from.

As its name suggests, long term disability insurance is designed to last longer than other types of disability coverage. It covers serious ailments that may endure for several months or even years. Permanent disabilities are also covered by long-term disability insurance.

That being said, you will need to design your policy based on your coverage needs and budget. This includes:

The definition of disability. This is the most important factor to consider when shopping for long term disability insurance. This will determine how much, and even if, you collect benefits following an injury or illness.

A policy’s definition of disability is based on your capacity to work. Maybe you’re unable to work in your chosen profession, but can do other work. A disability may allow you to work in a reduced capacity. Serious ailments can prevent you from working in any job.

To collect on a claim, you must meet the policy’s definition of disability. This can vary greatly by company and policy. The broader the definition, the more insurance will cost.

Benefit period. This is the maximum number of years your policy will pay benefits. It may be five years, 10 years, up to age 65, or even for a lifetime.

Elimination period. This is the time between when your disability occurs and when your benefits begin.

Additional riders and benefits. Many long-term disability insurance policies include optional features called riders. You can add them to enhance your coverage. Riders help customize a policy to fit your needs and preferences. Keep in mind that riders typically add to the cost of your policy.

Common riders can protect you in the event you’re not completely unable to work, provide cost-of-living increases on your benefits, enable you to increase coverage without additional underwriting, and tack on additional benefits.

What determines the cost and coverage of your disability policy

Insurance companies underwrite disability coverage based on the risk of an applicant filing a claim. They also consider how much a person might collect in benefits, and for how long.

Your policy will be underwritten based on:

The type of business you work in. Your career has a major impact on your premium rate. Insurance companies classify jobs based on the hazards of the work, as some are more prone to injury or illness.

Your career may also be assessed based on the difficulty in returning to work from an injury or illness. The more difficult it is to do a job with certain injuries or illnesses, the more the insurance company might have to pay in benefits.

Different jobs are grouped into specific risk classes. These are numbered on a scale of 1 to 5 or 6.

Typically, the higher the number, the less risk an insurer considers that profession. The lower the risk, the lower the premium rate.

When you compare policies, you should note that insurers assign different risk classes to the same profession. One insurer may designate a job as a 4, while another may classify it a 5.

Income. Disability insurance benefits are based on a percentage of your income. Therefore, a key part of the underwriting process and a determining factor of your premium is how much you earn. This is done through financial underwriting.

Age. Older individuals present more risk to insurance companies. They file disability claims at a greater rate than people who are younger.

Health. People in less-than-average health, who have chronic conditions, or who have used tobacco are more likely to suffer disabilities. The healthier you are, the less you will pay for disability insurance.

Learn more about the cost of disability insurance here.

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How disability insurance companies assess business owners

Every business is unique, which makes underwriting a challenge for insurance companies. For example, there’s a big difference between how a disability would affect a home-based sole-proprietor versus an owner of a 50-person construction company.

Many injuries and illnesses will affect a self-employed accountant’s ability to work differently than a self-employed mechanic. For example, the accountant can probably continue working if confined to a wheelchair, while the mechanic likely cannot.

Insurance companies will also base underwriting and coverage decisions for the self-employed on the following details:

  • The company’s net income.
  • The industry in which it operates.
  • The number of employees.
  • How long it’s been in business.

These attributes can dictate your disability insurance policy benefit amount, benefit length, and occupation class.

How disability insurers determine your income

The premium you pay for and the benefits you receive from will be based in part on your income. A key part of the underwriting process when you apply for coverage is determining how much you earn.

Determining the correct amount of coverage you qualify for is done through the process of financial underwriting. This is done largely to assess a person’s need for coverage and to avoid overpaying a claim if he or she becomes partially or completely disabled.

An underwriter will evaluate your earned income, unearned income, net worth and even your bankruptcy history, if applicable. You will have to provide the underwriter your individual tax returns and business tax forms.

For underwriting purposes, income is earned if it stops or would be significantly reduced because of a disability. Therefore, investment or business income that doesn’t require work on your part will not be factored into your financial underwriting.

How business income is determined

If you’re a full or partial owner in a business, the insurer’s underwriter will determine your income based on:

  • The legal structure of the business
  • How much of the business you own
  • Its earnings
  • How much you work/earn as an employee of the business

Say, for example, you have an ownership interest in a corporation or limited liability company (LLC). You also work in the business, either full or part-time. If so, your earned income will include:

  • Salary and wages
  • Regular overtime
  • Bonus and commissions (less expenses)
  • Your proportionate share of business earnings

For example, if you own a 50-percent share of a business that earns $100,000 a year, your disability benefits will be based on $50,000 in the earnings of the business, plus your salary.

If you’re a business owner, policies may also provide a business owner allowance. For example, a policy may provide an increase of your earned income by up to 20 percent if you are at least a 20 percent active worker owner of a business.

If you are the sole proprietor of the business or part of a partnership, the insurer will typically consider earned income the net profit of the business, after expenses, but before taxes.

In addition, some policies will also consider contributions made to a pension or profit-sharing plan as earned income, up to a certain percentage of their salary or other designated maximum, unless the contributions continue after you become disabled. Verification of the contribution is required.

As a business owner, your income and your company’s earnings likely fluctuate from year to year. In that case, the insurer will determine a maximum benefit amount using a weighted average over a two to three-year period. Also, a substantial increase in income from one year to the next (i.e., 20 percent or more) will require a detailed explanation.

Disability insurance for freelancers and independent contractors

Many people derive some or all of their income through freelance or contract work. In many cases, these workers do not own a business that is its own legal entity. At the same time, they are not legal employees of a company. Examples may include freelance writers/journalists, artists, personal trainers, computer programmers, data entry workers, and people who drive for rideshare services like Uber or Lyft.

If you earn income through freelance or contract work, you can qualify for disability insurance. As with all business owners at risk of losing some or all of their income due to illness or injury, you should strongly consider buying disability coverage.

If you’re a new freelancer, you will probably have to wait a few years to qualify for disability insurance. Most insurers will want to see evidence of at least two years of freelance income before agreeing to cover you.

Determining how much in benefits freelancers can qualify for is similar to financial underwriting for sole proprietors. Insurers will review tax returns over a two to three-year period to determine your average annual income, then base your benefit on that amount.

Insurers typically consider earned income the net profit of the business, after expenses, but before taxes. For example, as an Uber driver, your income for determining benefits will not include any expenses, such as gas, that you deduct from your taxable income. Likewise, graphic artists would have to deduct the costs of software and printing from their earned income.

Freelancers who buy disability coverage are getting personal coverage. This means you cannot consider your premiums a business expense for tax purposes. That also, means, however, that any benefits you receive will be tax-free.

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Business overhead insurance, explained

Business owners may need additional coverage beyond an individual disability policy. They should consider insurance that protects their business. This is called business overhead expense (BOE) insurance.

Whereas regular disability insurance covers individual income, a BOE policy will help cover your monthly business expenses if an injury or illness impacts your ability to work. The typical maximum monthly benefit is between $15,000 and $25,000.

You can obtain BOE coverage as a standalone policy or bundled with your personal disability policy. If you obtain BOE that is bundled with your personal disability policy, its maximum benefit may be a factor of that benefit amount. For example, the BOE benefit maximum might be equal to 12 times the benefit on your personal policy.

Business overhead insurance typically has a maximum benefit period of two years. If your disability lasts longer, the BOE coverage will at least keep your business afloat until you can sell, liquidate or arrange for somebody else to manage the operations.

If you have a business loan, your lender may require this type of insurance coverage. Lenders do not forgive business loans just because an owner is unable to work. But they also need to protect their capital investment and ensure they receive loan repayments if you can’t work.

An important thing to keep in mind is that your personal disability insurance policy will not pay enough in benefits to cover business loan payments AND meet your daily needs.

Just as with personal disability coverage, it’s better to buy BOE when you’re younger. The same underwriting principles apply to BOE as with disability coverage; your age and health will greatly determine how much you pay in premium.

Unlike your regular disability insurance policy, premiums for BOE coverage are tax deductible. That’s because the IRS considers it a business expense.

What business overhead insurance policies cover

BOE policies typically only cover the cost of your business overhead. The amount the policy pays in benefits will be based on the company’s monthly overhead expenses each month, up to a cap. For example, if you have a policy that pays up to $20,000 a month but your overhead totals $15,000, the policy will pay $15,000.

If you’re part of a partnership or multi-owner corporation, the BOE policy will likely cover your share of expenses. This is usually based on how much of the company you own at the time of disability.

Expenses that are typically included are:

  • Rent or mortgage payments on your business facilities
  • Utilities
  • Taxes
  • Employee salaries and wages
  • Business loan repayments
  • Business insurance premiums
  • Equipment maintenance
  • Building maintenance and janitorial services
  • Office supplies

Are self-employed workers eligible for SSDI?

Social Security Disability Insurance (SSDI) is a federal, payroll-tax funded program managed by the Social Security Administration. The taxes you pay into the Social Security system make you eligible to receive benefits if you become disabled.

If you are self-employed, you may be eligible for SSDI. Eligibility requires that workers have paid Social Security taxes. Employees typically do this through payroll deductions from their paychecks.

Self-employed individuals often pay the tax when they make their Social Security payments through their estimated tax payments or when they file their annual returns.

Keep in mind, however, that this isn’t true of all business owners. For example, owners of S corporations don’t pay self-employment taxes on their company profits. Therefore, these business owners would not be able to collect Social Security disability benefits unless they paid taxes to Social Security through other means, such as a previous job.

Because of the difficulty in obtaining SSDI benefits and the low monthly benefit, it’s advised that workers also have their own private long-term disability insurance.

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