Everything You Need To Know About Disability Income Insurance
Table of contents
- What is disability insurance?
- 3 main types of disability insurance
- Short-term or long-term disability insurance
- Other types of Disability Coverage
- How to qualify for disability insurance
- Important disability insurance riders and terminology
- When do disability insurance benefits start?
- What you should know about your disability insurance policy if you have one or are planning to purchase one
- Social Security Disability Insurance
- What you should know about Social Security Disability Insurance
- Taxation of disability insurance benefits and premiums deductibility
- 3 essential categories insurance companies look for when qualifying investors for disability insurance
- The 2% Rule
- Best practices for designing an affordable disability insurance policy
- What types of disability insurance do you need?
- Questions to ask yourself to see if disability insurance is right for you
- How much does disability insurance cost?
Everything you need to know about Disability Income Insurance
“7 in 10 working Americans couldn’t make it a month before financial difficulties” if they become disabled (1). One in four would have financial problems immediately if they cannot work (1). According to the Council for Disability Awareness, disability insurance claims rates show that approximately 90% of disabilities are caused by illness, not injuries (2). Hi everyone, my name is Tan and I am an independent CERTIFIED FINANCIAL PLANNER™ practitioner. Today, we are going to talk about disability insurance. In my practice, I’ve seen a lot of dentists and surgeons get disability insurance because they need to protect their hands.
What is disability insurance?
- Disability insurance is a protection against an illness or injury that may result in loss of income for a period of time. What does that mean? If you become disable, disability insurance will pay a percentage of your salary.
- The payments stop when you can go back to work, used all the benefits you purchased, and/or as stated on the contract.
3 main types of disability insurance
- 1. An individual policy where you buy from an insurance company. The premiums are higher than a group plan because it’s portable. Which means the policy is yours as long as you pay the premiums.
- 2. A policy part of a group plan where you buy disability insurance through your employer.
- 3. An employer-sponsored plan where the employer pays the premiums, you get the coverage, and the benefits are taxable to you as wages.
The premiums are lower on a group plan than an individual policy because you are buying a policy with a group of people, it may not have all the features and benefits compared to an individual policy, and most of the time, it’s not portable. Which means you no longer have coverage when you leave the company.
In addition, you want to know how you can qualify for disability benefits in the group plan because they normally only cover catastrophic events, but about “90% of disabilities are caused by illness (2).”
You can get short-term or long-term disability insurance
- Generally, short-term disability coverage is for less than 2 years and replaced up to 60% of weekly wages. For example, if you are making a $1,000 a week, the coverage is $600 a week.
- Long-term disability coverage is coverage for more than 2 years and replaces on average up to 60% of monthly gross wages. For example, if you are making $10,000 a month, the coverage is $6,000 a month.
- Clients often ask me, “why do insurance companies only cover up to 60% of my wages?” The answer is, the money is tax-free and there has to be an incentive for you to go back to work.
- Normally, there is a cap of $5,000 a month or 60% of wages, whichever is greater for short-term disability coverage and no cap for long-term disability coverage.
Other types of Disability Coverage are:
- Guaranteed Issue Multi-Life - simple underwriting for businesses with 10 or more people.
- Fully Underwritten Multi-Life - regular underwriting for groups or employees applying for policies together.
- Business Overhead Expense - reimbursement for documented overhead expenses.
- Buy-Sell Protection - for multiple owners in a company to fund a buy-sell agreement.
- Key Person - protects the business should a key-employee become disabled.
- Loan Protection - reimbursement for a loan payment.
- Accidental Death & Dismemberment - lump sum payment for accidental death or dismemberment.
- Critical Illness - lump sum payment for a diagnosis of a pre-specified illness.
- High Limit Supplement - for high income-earners who want more protection on top of their current policy.
- There are other types of disability coverage but it’s not for the majority of investors.
How to qualify for disability insurance
It depends on the types of policy you have and the definition of disability. For example,
- Own occupation - You qualify for benefits when you cannot do your current job but can do other jobs. This type of policy is the most expensive.
- Modified own occupation - You cannot do your current job and you cannot be working to claim benefits.
- Any occupation - You cannot do any job.
- Modified any occupation - You cannot do any jobs that are similar to your current job and you can easily become qualified.
- Popular disability insurance policy design in the industry is two years own occupation then any occupation. Why? You start out easier to qualify for benefits than other options and to keep the premiums low compared to a policy that is only own occupation. For example, the policy will cover you for 2 years if you cannot do your current job then it will cover you until age 65 if you cannot perform a job that is similar to your current job and a job that you can easily qualify.
Important Disability Insurance Riders and Terminology
- There are so many riders and terminology in disability insurance, but I only want to cover the most important ones.
- Benefit period - How long you can collect benefits. It could be 2 years, 5 years, until retirement, until age 65, etc.
- Inflation protection - This feature allows your benefits to increase by 3% or 5% at a simple or compounding rate annually. If you are young, you want some type of inflation protection. If you are near retirement, you might not want it due to the extra cost relative to the higher benefits in the future.
- Waiver of premium - I really like this feature because you do not have to pay the policy premiums if you are disabled and collecting benefits.
- Residual rider - If you return to work at lesser pay after being disabled, the policy will pay the difference between the former pay and the current pay if there are available benefits.
- Partial disability rider - You cannot perform one or more important duties of your own occupation but are still able to perform other duties.
- Guaranteed insurability rider - You have the right to purchase additional coverage in the future without going through underwriting.
- Social Insurance Substitute (SIS) rider - Provide benefits that are integrated with Social Security, workers’ compensation, or other social insurance. The benefit is reduced dollar-for-dollar. For example, you receive $4,000 a month from your disability policy, $1,000 a month from social insurance substitute (SIS), and $300 a month from Social Security disability benefits. How much money will you receive monthly? You will receive $4,700. $4,000 from the disability policy and $700 from Social Insurance Substitute ($1,000 - $300 receives from Social Security).
Disability policy benefit + (Social Security Substitute - Social Security benefits).
$4,000 + ($1,000 - $300) = $4,700
$4,000 + $700 = $4,700
- Non cancellable - This policy guarantees you can renew the policy at a fixed level premium until a specific age or stated number of years.
- Guaranteed renewable - This policy guarantees you can renew the policy, but the insurance company has the right to adjust the premiums.
- Conditionally renewable - The insurance company may terminate the policy under certain conditions.
- Conditions automatically qualifying for the full benefit are blindness, deafness, loss of speech, loss of two or more arms and legs.
When do disability insurance benefits start?
- Elimination period plus 30 days, but remember to read and understand your contract.
- You should have an emergency fund to cover the elimination period plus 30 days because the benefits paid at the end of each month.
- When you see 30 days elimination period, it means you will get the first paycheck in 60 days.
- If you see 60 days elimination period, it means you will get your first paycheck in 90 days. Why? Because benefits are paid at the end of each month.
- Longer elimination period will have a lower premium than a shorter elimination period because the insurance company can pay benefits later and by the time you start to receive benefits, you are better and can go back to work.
What you should know about your disability insurance policy if you have one or planning to purchase one
- You should really understand your policy and know how to qualify for benefits.
- What is your policy definition of injury and sickness?
- Are there any exclusions?
- Does the policy have Social Security disability benefits offset provision? Some long-term policies provide a dollar-for-dollar reduction in benefits when you receive Social Security disability benefits. For example, the policy states it will pay you $1,000 a month when you become disabled. If you receive $600 a month from Social Security disability, the policy will only pay out the difference which is $400 a month.
- You want to purchase a non-cancelable or guaranteed renewable policy because you want to make sure you can continue your policy when you need it most.
Clients often ask me, what about Social Security Disability Insurance?
- The definition of disability under Social Security is that “Social Security pays only for total disability.
- No benefits are payable for partial disability or for short-term disability.
- You cannot do work that you did before;
- You cannot adjust to other work because of your medical condition(s); and
- Your disability has lasted or is expected to last for at least one year or to result in death.
- This is a strict definition of disability (4).”
What you should know about Social Security Disability Insurance
- The process takes about 2 years.
- It’s a long process and hard to qualify for.
- Social Security is looking for ways to not pay a claim because the benefits are only for those that really need it.
- The average disability payment is $1,198 a month (5)
Taxation of disability insurance benefits and premiums deductibility
- If you purchase an individual policy and you paid for it, the benefits are tax-free and you cannot deduct the premiums on your tax return.
3 essential categories insurance companies look for when qualifying investors for disability insurance
- 1. Investor’s health and medical history.
- 2. Verification of earned income.
- 3. The investor’s occupation.
The 2% Rule
- The annual premiums should be around 2% of the investor’s annual income to ensure affordability.
- For example, if you are making $100,000 a year, $100,000 X 2% = $2,000 in annual premium for disability insurance.
- If you are making $50,000 a year, $50,000 X 2% = $1,000 in annual premium.
Best practices for designing an affordable disability insurance policy
- Reduce the benefit period to five years.
- Reduce the benefit amount.
- Reduce the residual option.
- Remove the Cost of Living Adjustment Rider, which is called COLA.
- Remove Catastrophic, Future Purchase Option, and other riders.
- Extend the elimination period.
- Get quotes from multiple insurance companies.
What types of disability insurance do I need?
- Income protection is important, but disability insurance is not for everyone and it’s not a one-size-fits-all products.
- It depends on what is your personal needs, age, occupation, income, net worth, financial responsibility, etc.
- It is important to remember that some coverage is always better than none.
- Always make sure you are able to cover your basic monthly expenses.
Questions to ask yourself to see if disability insurance is right for you
- How long could I afford to pay my basic monthly living expenses if I were unable to work due to a sickness or injury?
- How long could I continue to pay the mortgage if I were unable to earn money?
- How would my family’s lifestyle be impacted if I were unable to earn an income?
- What is my plan if I cannot go to work tomorrow?
- If I become disabled, who will take care of me?
How much does disability insurance cost?
The cost depends on a lot of factors, such as:
- How much coverage do you want?
- What type of coverage do you want?
- How long do you want to be covered for?
- How old are you?
- What is your current health and medical history?
- What is your occupation?
- What additional riders do you want on the policy?
- If you would like some quotes, please visit tanphan.com/insurance-quotes to fill out the form so I can shop around for you.
In life, we have a lot of plans, such as getting married, having kids, owning a home, starting a business, taking care of our family, and making the world a better place for the next generation. A plan is only as good as the cash flow that is coming in.
A plan is only as good as the cash flow that is coming in.
Thank you for watching. Until next time, this is Tan. Your trusted advisor.
References:
(1) ”What Do You Know About Disability Insurance” survey, Life Happens, 2018
(2) Council for Disability Awareness, Long-Term Disability Claims Review, 2013
(3) The Disability Survey conducted by Kelton Research on behalf of Life Happens, April 2012
(4) https://www.ssa.gov/planners/disability/qualify.html
(5) Social Security Administration, Fact Sheet June 2018, https://www.ssa.gov/news/press/factsheets/basicfact-alt.pdf
This material is for educational use only and does not constitute tax, legal, or investment advice. Information may be changed or updated without notice. Consult with a licensed professional regarding your personal circumstances.
Please do not excerpt or copy this information without prior consent from TAN Wealth Management.