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How much disability insurance do I need?

Buy too much coverage, it’s a waste of money. Buy too little, you may regret it later. Here’s how to find your happy medium.

No matter what type of insurance you look to buy, one question usually comes up: How much do I need?

It’s an important question to consider. Buy too much of any type of insurance and you’re wasting money on premium. Get too little, however, and you will lack coverage at the time you need it the most.

The question of how much insurance you need is more complicated when it comes to disability insurance. That’s because there are a number of coverage options and moving parts with disability insurance.

The easiest way to answer this question is to consider just what disability insurance covers. It is designed to replace a significant portion of your income in the event you can’t work due to an illness or injury.

Therefore, your disability insurance benefits should replace as much of your income as possible.

But there’s more to disability insurance than just a benefit amount. To better answer the question of how much disability insurance you need, you first need to answer the following questions.

What is your current income?

Since disability insurance is designed as income replacement, this is the best place to start when assessing how much coverage you need.

If you earn a regular paycheck, this is a pretty easy question to answer. The challenge is trying to determine your coverage based on variable income such as business income, contract work, or working on commission.

One thing to keep in mind when comparing your current income with your disability benefits is taxes. In most cases, benefits from a disability insurance policy are income tax-free. If you’re not earning taxable income because of a disability, then your disability benefits don’t have to replace all of your pre-tax income.

What are your financial obligations?

Just because your income stops due to a disability doesn't mean your bills will. In most cases, there is no loan forgiveness for a disability. You will still have to pay your mortgage, car payment, credit card bill, and student loans.

Make sure your coverage, at the very least, covers these obligations to minimize the possibility of default or bankruptcy.

For other expenses, such as food, utilities, and gas, look at your current budget and determine what you spend on the absolute necessities.

How much do you have in savings?

If you have a significant amount of money saved, it’s possible to elect a higher overall benefit amount while choosing a longer elimination period.

Your policy’s elimination period is the period of time between when the disability occurs and when benefits are paid. For example, a policy with a 60-day waiting period would not pay benefits for the first 60 days after the insured becomes disabled.

The longer the elimination period on your policy, the less you will pay in premium. If you can use your savings to get by for, say, six months, then you can elect a 180-day elimination period. The money you save by choosing a longer elimination period can be used to purchase a longer benefit amount or other features.

Do I need long term disability, short term disability, or both?

Short term disability insurance is for temporary, less serious injuries. Long term disability insurance is designed to last a year or more if you become disabled.

Long term disability insurance is more expensive than short term disability. But it offers greater protection. Therefore, you are advised to not skip long term coverage in lieu of having just a short term policy. Short term coverage will not be adequate if you suffer a serious injury or illness.

Depending on how much you have in savings, you may be able to forgo short term disability coverage unless it’s available at minimal cost through your employer.

How long should I collect benefits?

You can choose how long a disability insurance policy will pay benefits. The longer you receive payments, the more you pay in premium. Some policies will pay a monthly benefit for a pre-established period, such as 10 years. Others will pay until you reach a certain age, typically 65. A few insurance companies have an option that pays lifetime benefits if the insured remains disabled for life.

Do I need own-occupation coverage?

An own-occupation disability insurance policy protects your ability to work in your given profession. You will be covered if a disability prevents or limits you from working the job you had before your event. If you’re able to work in another capacity, you are still eligible for benefits.

This type of coverage is especially important for high-skilled professionals who make large salaries. Without an own-occupation policy, you could be left without benefits even though you can’t work in your given profession simply because you are healthy enough to perform other less-paying work.

Will I make significantly more income in the future?

One concern about disability insurance is buying a policy today based on your current income, but making significantly more in the future when you might need to collect benefits. If your policy pays benefits based on the lower-income amount, it may not meet your future needs.

If you anticipate significant income increases after you are issued a policy, you should strongly consider a future Increase rider. It will help ensure your disability insurance policy benefits keep pace with your income.

A future increase rider, also known as a future purchase option, enables you to increase your coverage amount. You can do this at designated future dates or if certain life events occur. Plus, you can do so without going through underwriting again. How much and how often you can increase your disability benefits depends on your policy.

Do I need to consider inflation?

If you buy a standard disability insurance policy, your benefits will remain the same amount for as long as you receive them. But the cost of other items, such as food, utilities, and medical care, will increase over time due to inflation.

So how will an unchanging benefit amount provide for your needs if basic items increase in price?

It can if you opt for a cost-of-living adjustment (COLA) rider. This feature will increase your benefit amount each year you are disabled.

Because this rider can be relatively expensive, it’s not recommended for all applicants. The younger you are, the more you should consider a COLA rider because inflation will have a greater potential impact the longer you have the policy.

Jack Wolstenholm is the head of content at Breeze.

The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.