If you were told you had a one in four chance of winning the big lottery jackpot, how many tickets would you buy? Probably, as many as you could. What if you were told that you had a one in four chance of losing your income before you turned 65? That could also be a motivating number for you.
According to the U.S. Social Security Administration, 25% of Americans will experience a disability in their careers before they retire, and 90% of those long-term disabilities will come from illness, not an accident.
For 70% of working Americans, going one month without a paycheck would create severe financial difficulties. How about going two years without a paycheck? Could those Americans keep a roof over their heads, food on the table, and still allow the kids to continue to participate in their activities?
These are sobering statistics and questions, and they’re not meant to scare you. But if you haven’t taken steps to protect your biggest asset, which is your ability to earn a living, this article will give you some important information about disability insurance, which is designed to provide you with a steady income if you become sick or injured and are unable two work.
Let’s look at five types of disability insurance you need to know about, starting with individual coverage, which is critical to have if you don’t have a group disability plan at work.
Which is more valuable, your automobile or your future earnings? You can probably guess, but let’s look at an example.
Richard is a healthy, 35 year old male who earns $50,000 per year as a self-employed contractor. If Richard’s annual income never rose by a penny and he continues to work until he’s age 65, Richard will conservatively earn $1.5 million over the next 30 years. With just a 3% annual cost of living increase, the number would be closer to $1.75 million.
Richard’s car is two years old and has a resale value of $25,000. He has comprehensive automobile insurance in case of an accident, but he has no individual disability insurance to protect his biggest asset, which in his case is the ability to earn $1.5 million. What should Richard do?
Richard obviously shouldn’t run out and cancel his car insurance, but he should protect his income by investing in an individual insurance policy. If you’re noticing that you are risking your most significant asset by not protecting it, individual disability insurance is the solution.
Let’s take a look at what you need to know about individual disability insurance so you can choose the right coverage.
There are three components of a disability policy that you need to make decisions about as you build your coverage: benefit period, elimination period, and benefit amount. Let’s examine each.
- Benefit period: This is how long you want to receive a monthly check from the insurance company that issued you the disability policy. You can select from various lengths of time, such as 2 years, 5 years, or until retirement age. The longer the benefit period, the higher the monthly premium is.
- Elimination period: Also known as the waiting period, this is the period of time when your disability begins until you start to receive a check from the insurer. Elimination periods can be as short as 90 days or as long as one year. The elimination period that’s best for you can be arrived at by asking yourself how long you could live off of your savings if you can’t work.
- Benefit amount: How much money do you need to meet all of your financial obligations each month? The good news is that your disability policy can provide you with 60-70% of what you need. That may seem a bit low to pay your bills, but bear in mind that the money you receive is tax-free, meaning your net income each month won’t be all that much different than what your take-home pay is right now.
Hopefully, you realize how important it is to protect your income, which in turn saves you and your family from financial disaster. Your next question is probably, “I need it, but how much does it cost?”
In addition to the three components of a disability policy you selected from, four personal factors will also affect the cost of disability insurance. They include your:
- Job responsibilities
The state you live in can also factor into your premium, depending upon regulations and the claims experience the insurer has had in your state.
Let’s use Richard, whom we talked about earlier, as an example of what disability insurance would cost.
Richard’s monthly gross income is just over $4,000 per month. To replace 60% of that amount per month, $2,400, it will cost Richard $53 per month. In this case, the benefit period is 5 years. The total payout to Richard over those five years will be $150,000 if his disability lasts that long (the average length of a disability for someone in their 30s is just under three years).
Now that you’ve got a good handle on the benefits of having disability insurance and how it’s priced, if you are employed by an organization that offers employee benefits, disability insurance may be one of those benefits. Many companies offer two types, short-term disability insurance and long-term disability insurance. Let’s look at both.
- Short-term disability Insurance: A good policy to have because it supplements your long-term disability coverage. The waiting period is much shorter, it can be just a few days. The benefit period is also shorter; benefits can last up to one year.
- Long-term disability insurance: It's similar in structure to an individual disability insurance policy as far as its components and pricing. Elimination periods can be as long as one year, and you can coordinate your long-term disability coverage to begin when your short-term coverage ends. That way, you’ll have no gap in coverage.
If your employer only offers short-term disability insurance as an employee benefit, you’ll want to take out an individual long-term disability policy to ensure that you are adequately protected against lost income for a longer period of time. Short-term disability insurance is good to have, but it’s not sufficient by itself to protect you and your family if you can’t work.
Learn More: Group Disability Insurance
One thing we haven’t talked about is your insurability. When you apply for an individual disability insurance policy, the insurance company will ask you questions about your medical history, and they may require you to have a physical exam (at their expense). Similar to when you buy life insurance, the insurer will evaluate the information they receive and either accept or reject your application. If the insurer declines to cover you and you have a mortgage you’re concerned about, mortgage disability insurance may be an option for you to consider.
As its name implies, this long-term coverage is specifically designed to make your mortgage payment if you become disabled. It can be obtained through your lender or an insurance broker. What makes mortgage disability insurance so appealing is that if a disability insurer declines you, you can get mortgage disability insurance without going through the typical underwriting process or medical exam that you do for an individual disability insurance policy.
Bear in mind that this policy’s monthly benefit will only be for an amount that will make your mortgage payment for you. That’s a valuable benefit, but you’ll still be left with all of your other monthly expenses. Having an emergency fund (savings account) of 6-12 month’s income is advisable and can be a real lifesaver.
Learn More: Mortgage Disability Insurance
Social Security disability insurance (SSDI) is not something you can count on — over 60% of all applicants are denied benefits because the definition of disability is so stringent.
To make matters worse, it can take three to five months after an arduous application process to find out if you’ll be receiving benefits. The reward for running the gauntlet (if you’re approved): an average benefit of about $1,000 per month. Having a private disability policy is a much better option.
Learn More: Social Security Disability Insurance
There are a few states that have their own disability insurance plan for workers:
- New Jersey
- New York
- Rhode Island
- Puerto Rico
These are short-term benefit plans: New York’s plan covers up to 26 weeks and California up to 52 weeks, demonstrating the need to have your own long-term disability insurance policy. State disability insurance can’t be purchased through an agent or broker.
Learn More: State Disability Insurance
As you can see, if you have financial responsibilities and bills that have to be paid every month, disability insurance is a must-have. An insurance broker can compare several different policies with several different insurers to find you the right coverage. Don’t delay — the best time to apply for disability insurance is when you’re healthy.
Having grown up in upstate New York, Bob Phillips spent over 15 years in the financial services world and has been making freelance writing contributions to blogs and websites since 2007. He resides in North Texas with his wife and Doberman puppy.
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