Are You Underestimating Your Need for Disability Insurance?

Long-term disabilities are probably more common than you think: About one-third of us will experience one before age 65. But before you buy insurance, learn the ins and outs of long-term disability policies.

By Deborah L. Meyer, CPA/PFS, CFP®

published 29 August 2018

in Features

If you underestimate your risk of disability, you’re not alone … only 10% of individuals accurately estimate their chance of disability, according to a study by the Council for Disability Awareness. TMA Insurance Trust shares some startling statistics:

Applying for Disability Benefits During a Global Pandemic

One in 8 workers will be disabled for five years or more during their lifetime.
The average group long-term disability claim lasts 34.6 months.
90% of disabilities are caused by illness, not accidents.

Short-term (“ST”) disability policies cover six months of disability or less. It’s typically better to build up cash reserves rather than pay a premium on a short-term disability policy. On the other hand, it is much more difficult to build enough cash reserves for a disability that lasts years. That is precisely why long-term (“LT”) disability insurance is a necessity.

Premiums on individual LT disability policies are usually higher for women than men, especially ones in their childbearing years, because the likelihood of disability is greater. Life insurance is the opposite: Men’s life insurance premiums are typically costlier than women’s premiums to account for a shorter male life expectancy.

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Important Distinctions on Definitions of Disability

How a policy defines the meaning of “disability” sharply impacts your ability to collect benefits. “Own occupation” and “any occupation” are the two primary categories of coverage.

“Own occupation” policies pay disability benefits if you can’t perform the duties of your own occupation. So, if you’re a lawyer and your disability keeps you from working as a lawyer, then you would receive benefits — even if you’re well enough that you choose to take another job outside your field.
“Any occupation” policies, on the other hand, are much more strict. They only pay benefits if you are unable to work in any “gainful occupation.” So, if you’re an accountant, your benefits could be denied if you were able to work as a cashier instead.

Another thing to keep in mind is that not all own occupation policies are created equal:

With “true own occupation” policies, your disability benefit is not affected by any salary you might earn at a job you take while you’re disabled.
“Transitional own occupation” policies would pay reduced benefits based on any salary you earned if you chose to work while disabled. For example, your disability benefits will be reduced to $2,000 monthly under a transitional own-occupation policy if your disability coverage is $7,000 monthly and you’re earning $5,000 monthly during the disability.
With “modified own occupation” coverage you cannot receive any disability benefits if you take another position during your disability. You can still receive benefits even if you can work at another job, but not once you actually take a job.

3 Main Groups of People: Which Type Are You?

Now, let’s delve deeper into disability insurance policies for three distinct groups of people: those covered by an employer group plan, self-employed people or those not covered through an employer, and stay-at-home parents.

1. Covered by an employer group plan

Consider yourself lucky if you remain in this category. Typically, large employers offer short- and long-term disability policies at no cost to employees. While terms vary, benefits of 50% to 60% of pay are typical for an employer-provided LT disability policy. If you are not paying a premium on the disability policy, you will be taxed on the income you receive when collecting disability benefits.

A Financial Adviser Shops for Her Own Disability Insurance

I’ve noticed that government employees have different disability benefits than most employees of large companies. Short-term disability usually is not offered for government workers since sick pay should first be exhausted, and the level of LT disability benefits depends on the duration of the disability. The first year of disability is covered at 60%, but years 2 and beyond only offer 40% of pay. For this reason, I often recommend a supplemental policy for government employees.

If you do not feel comfortable with the level of coverage provided by your employer, you can shop around for a supplemental LT disability policy. The insurance carrier would take your current coverage in consideration to assure you do not make more money (after-tax) as a disabled person than if you were still on the job.

Work with an insurance broker who specializes in disability insurance and focuses on long-term coverage. Policies and carriers differ significantly, so gain a solid understanding from the broker about the nuances of the policy, also known as riders. Salary raises provide a higher probability of underinsurance, and therefore automatic benefit increases are helpful but more costly each year.

2. Self-employed or not covered by a group plan

This group is vulnerable to having inadequate levels of disability coverage or simply not having it at all. I have been self-employed since 2014 and am fortunate to have disability insurance through two professional organizations. One organization offers life and disability insurance policies to all its members through Aon. Within the group policy, members individually select a 13-week or 26-week waiting period. Extended waiting periods lower the premiums you pay. Furthermore, members may individually elect coverage for partial disabilities. This type of policy is more expensive because it does not require someone to stay out of the workforce completely when disabled, and it falls under the true own-occupation definition of disability.

What if you are in a profession that does not offer group plans? You can buy an individual LT disability policy, but these policies are expensive — sometimes as high as 3% of income. Remember, you can control the duration of coverage. To help control costs, consider delaying the benefit commencement date and limiting the duration. For instance, if the 13-week waiting period with lifetime benefit is too expensive, investigate a policy with a 26-week waiting period and up to five years of benefits. Exercise caution with this strategy: You’ll need enough financial resources to support the first six months of your disability and any disability that extends beyond five years.

3. Stay-at-home parents

Presumably, you must have earnings to get disability coverage. Stay-at-home parents are not paid anything for their contribution to the household and typically would not qualify for disability coverage. Focus on maximizing the sole income earner’s disability insurance coverage instead.

Planning is a Process

Disability insurance is just one of the many topics that comprehensive financial planners like me discuss with clients. Fee-only fiduciary advisers sign a legal oath to act in their clients’ best interest and are solely compensated for advice, not products they sell. If you are concerned about your level of insurance coverage or simply want an independent viewpoint, I’d encourage you to consult a NAPFA adviser.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Deborah L. Meyer, CFP®, CPA/PFS, CEPA and AFCPE® Member, is the award-winning author of Redefining Family Wealth: A Parent’s Guide to Purposeful Living. Deb is the CEO of WorthyNest®, a fee-only, fiduciary wealth management firm that helps Christian parents and Christian entrepreneurs across the U.S. integrate faith and family into financial decision-making. She also provides accounting, exit planning and tax strategies to family-owned businesses through SV CPA Services.