Who needs disability insurance? “Anyone who needs life insurance needs disability insurance,” says Steve Weisbart, chief economist and senior vice president at the Insurance Information Institute in New York City. “The basic idea is to replace an income that you depend on.”
Disability insurance actually is more crucial than life insurance, notes certified financial planner Greg Plechner. This is because the likelihood of someone becoming disabled and unable to earn an income at some point in his or her working life is greater than the likelihood of dying during the same period. Disability insurance is especially important for younger workers with dependents, but it’s good to have even if you don’t have dependents. It’s even more important for families that rely on one salary rather than two, Plechner said.
According to the American Council of Life Insurers, as many as one-third of people in the U.S. between 35 and 65 will become disabled for more than 90 days, and one in seven of them will be unable to work for more than five years—a long time to survive without a paycheck. Most cases are caused by illnesses such as arthritis, back problems, and heart disease.
If you’ve ever had health benefits at work you’re probably familiar with sick leave. Once your sick-leave is used up, short-term disability coverage provides employees who can't work with a percentage of that employee’s earnings or a fixed dollar amount for a fixed number of weeks. Generally, group long-term disability benefits start when short-term benefits are exhausted and continue anywhere from five years to life. Those benefits generally replace about 60 percent of salary. For Carolina, a mother of two young children, long-term disability was “very handy, since I was out of work for a whole year, and I was paid!”
Disability insurance falls into three main categories: employer-provided, private individual, and government-sponsored policies. Though not all employers provide supplemental disability coverage, it’s generally a good thing to sign up for when it’s offered.
Private individual policy underwriters, says Weisbart, “will look at your health and be more careful” than insurers providing employer-sponsored group coverage. But the advantage of an individual policy is that “if you later develop a problem or lose your job, you can keep it,” Weisbart notes. “It travels with you. If you have a job as a freelancer, it’s good to have it.” Most folks seeking an individual policy can expect to get no more than about 70% of gross income (about the amount you can expect from an employer-provided plan). Insurers will be worried about people who want too much.
Social Security has a disability insurance policy, “but it’s not something anyone should count on,” Weisbart cautions. The conditions needed to qualify are your inability to do any job, and a disability that lasts two years. He advises people to plan as though it’s not there.
If you choose to supplement a work plan, “Make sure your group plan benefit is not offset by an individual policy you’re considering,” suggests Plechner. In other words, if you want to keep your group plan’s benefit, read the fine print on both policies to make sure an individual policy does not prevent you from collecting from the group plan. And if you have group insurance through work, Plechner advises that you verify whether you (the employee) will pay the premium directly, so any benefits will be tax free. If your employer pays the premiums, any benefits will be subject to income tax payable by the employee.
Someone earning $100,000 might be able to buy coverage that pays up to $60,000 a year. If you get that coverage through employer-paid premiums, you'll net only $45,000 or so after taxes. Buying coverage with after-tax dollars can deliver untaxed benefits, increasing the amount you'll get to keep.
Should you get disability insurance even if you have debt? “Absolutely,” says Weisbart. “If you’re disabled and can’t pay off your debts, you’re in even bigger trouble.” You may get offered a disability plan through your credit card or mortgage lender, but “those don’t make financial sense,” says Weisbart.
Finally, if you have a choice, it pays to buy the insurance with the longest period of coverage you can buy. “The basic rule of buying is to insure against the most catastrophic stuff you could encounter,” says Weisbart. People may find disability insurance expensive, but “if you’re doing the calculations and ask yourself, ‘What’s the cost of doing without income for a couple of years?’” the coverage might make more sense.
Learn more about disability insurance and ways to protect your assets.