The Social Security Administration estimates that “one in four of today’s 20-year-olds will experience a long-term disability before reaching age 67” (See, 2024). This article will explore disability insurance, its part in a financial plan, and the basics before purchasing a policy.
What is the purpose of Disability Insurance?
Disability insurance provides you with income if you cannot perform work duties. You can be covered for two time frames: short-term (3-6 months) and long-term (over one year). According to this Federal Reserve article, only 40 percent of US households have enough liquid savings to cover at least three months of their recurring expenses, and only 28 percent can cover at least six months. Due to an emergency fund target furnishing only 3-6 months of living expenses, it is essential to protect your lifestyle if you lose an income.
Two types of disability insurance are own occupation and any occupation. If you have own occupation disability insurance, you will be considered disabled if you cannot continue the specific job you had before becoming disabled. On the contrary, if you have any occupation disability insurance, you can collect disability insurance only if you can’t perform any job you are reasonably suited to do. This is based on age, previous salary, knowledge/education, and skills.
How Much Disability Insurance Should I Have?
Through your job, you are likely to qualify for group employer-sponsored disability coverage. Often, your company pays the premiums. However, coverage is usually limited to 60% of your income. You should be enrolled in your employer policy, but ideally, you want to cover at least 80% of your current income or to maintain your current lifestyle. How will you fill in the gap? It might be a good idea to purchase a private disability insurance policy. If you become disabled, insurance companies offer different ways to compensate you during this time. You might get paid a percentage of your salary or continuously receive a fixed dollar amount. This is all based on your previous income. Below is an illustration by US Bank, pointing out differences in typical short/long-term and employer-sponsored/private policies.
(U.S. Bancorp Investments, 2023)
As seen above, policies have a “waiting period,” also known as an “elimination period.” This is the time you must wait to begin receiving benefits. Keep this in mind when choosing coverage and when building your emergency fund. Using your emergency fund during the waiting period can be a good strategy until your disability benefits begin.
When Should I Obtain Disability Insurance?
If you support dependents, your spouse, or your family, you should consider disability insurance. If someone is reliant on your income stream, you want to protect that so there is no financial strain if something unfortunate occurs. Disability insurance is not permanent, and you typically won’t need it when you no longer depend on your salary and have built enough assets to “self-insure.” These graphs created by ACLI show that the importance of protecting yourself and your family against income loss is higher in the early stages of your working career. The necessity often decreases as you age and become financially independent.
(American Council of Life Insurance, 2017)
Should I Choose Own Occupation or Any Occupation?
I have explained the difference between own occupation and any occupation, but how do you know which one to purchase for you situation? A rule of thumb is that the more specialized your job is, the more beneficial an own occupation policy would be. Own occupation has the most robust and comprehensive coverage. If you are a high earner, you should consider own occupation because what are the chances you find a job that provides the same income, especially when disabled? For example, a doctor/surgeon might have difficulty finding a job they are sufficiently educated for that isn’t in the medical field. Sure, you might be able to find another job, but that could drastically change pay, which would translate to living a different lifestyle.
Why Obtain Disability Insurance
According to the Council for Disability Income Awareness, one in four adults will become disabled before retirement age. Disability insurance provides an income while you cannot work and helps cover costs associated with a ‘qualifying’ injury or illness. If you become disabled, you might need income coverage for the rest of your life. An employer policy might only cover you for a specific period of time, but you can always obtain private disability insurance to ensure you are covered for a longer time frame. Disabled people are much less likely to be in the workforce than able people. This might be something to consider if you have any occupation disability insurance and might have to look for a different job if you become disabled. Granted, if you can obtain a job while disabled, there might be a pay gap from your previous salary that insurance can help bridge.
Many times, obtaining disability insurance will bulletproof a financial plan until reaching financial independence, when the insurance may no longer be needed. It also provides peace of mind knowing that you and/or your family are protected in case something unfortunate befalls you and your earning potential drastically changes.
What Qualifies as Short-Term Disability?
Short-term disability covers 3-6 months following the elimination period (if applicable). According to the Council of Disability Income Awareness, The top 5 events that might cause you to be eligible for short-term are:
- Pregnancies (22.3%)
- Musculoskeletal disorders affecting the back and spine, knees, hips, shoulders, and other parts of the body (18.5%)
- Injuries such as fractures, sprains, and strains of muscles and ligaments (11.4%)
- Digestive disorders, such as hernias and gastritis (7.4%)
- Mental health issues including depression and anxiety (7.3%)
What Qualifies as Long-Term Disability?
Long-term disability kicks in when you’ve been disabled for over one year, including the elimination period. According to the Council of Disability Income Awareness, the top 5 disorders that qualify you for long-term disability are:
- Musculoskeletal disorders (27.6%)
- Cancer (15.0%)
- Injuries such as fractures, sprains, and strains of muscles and ligaments (12.0%)
- Mental health issues (9.3%)
- Circulatory (heart attack, stroke) (8.2%)
How to Obtain Disability Insurance
If you work with a Financial Planner, they can recommend an insurance broker or service that can provide disability insurance quotes based on the specifications suited to your situation.
However, if you are searching for a policy independently, PolicyGenius is a great resource to get started. Determine how much income replacement you need in congruence with employer-sponsored disability insurance, how many months your emergency fund can cover your current lifestyle, and how long the disability insurance should cover (typically to full retirement age). Once the quotes are obtained, you can toggle different coverages to increase or reduce premiums and determine whether the cost justifies outsourcing the risk of disability.
The Bottom Line
For most young families with spouses and/or children who rely on their income, it’s almost always beneficial to protect your income and guarantee that your lifestyle and goals can remain on track should a disability befall you. As your net worth grows over time, disability insurance becomes less of a concern. You may even reach a point where it makes sense to let your disability insurance lapse, as your assets could support your lifestyle even if a disability occurs. If you need assistance reviewing whether a disability insurance policy makes sense, schedule a free consultation today!
