It’s fairly common to have at least a small understanding of life insurance, but it’s not often we hear about disability insurance. Every now and again, you’ll hear that a friend is “out on disability,” but what does that really mean and what types of disability insurance are out there?
There are two very different types of coverage – short term disability and long term disability. Depending on your policy and your state’s laws, short term coverage generally covers a period under 1-2 years – although many policies cover a much shorter timeframe, say 3 months. Short term coverage is only available through an employer. Many plans allow you to carry over a limited amount of unused vacations days (up to a maximum) to add to your “short term disability bank.” If your employer doesn’t offer this coverage (or if you’re self-employed), you may want to consider having a 3-6 month savings set aside in the event that you suffer a disability.
Long term disability (LTD) is meant for illnesses or injuries that prevent you from working for at least several months. Coverage may be available from an employer and/or from an outside source, such as an association to which you belong. This is where things get tricky.
Employers like to tout that benefits like LTD are paid on a pre-tax basis. While that is attractive when you are paying your premiums, those benefits have to be taxed sometime – and that sometime is when they are paying out. What that means is that if your policy replaces 60% of your income, that 60% payout is going to be taxed – meaning less money to pay bills. Another caution with employer plans is that they are not portable. If you leave the company, the policy will cease to exist.
If you purchase an external plan, the inverse is true. Your benefit amount will not be taxed and you keep the policy so long as you remain eligible and continue to pay your premiums – regardless of switching employers. You may also find better rates if you’re purchasing through an association group plan.
Long term disability policies differ in pricing based on a “waiting period” (sometimes called an “elimination period”), or the period you have to wait from the time you incur your disability until the time the policy starts paying. 30, 60 and 90 day waiting periods are very common. Prices decrease for longer waiting periods. This gap is where your emergency fund or STD policy can be critical to staying afloat financially.
It’s important to note that disability coverage isn’t health insurance. The money is not earmarked to only pay medical bills. It should be thought of as income replacement that allows you pay for your normal bills until you get back on your feet again.
A feature you will want to look for is called “own occupation.” In other words, the policy considers you to be disabled (with some other stipulations, such as the inability to do certain activities of daily living) when you cannot do your exact job, not just any job.
You will not find a policy that will replace 100% of your income and insurance companies require you to disclose other policies to ensure the addition of their policy does not equal a high percentage of your income. Policies will generally pay around 60% of your income – with some plans going as high as 80%.
LTD insurance typically requires full underwriting, which means you will fill out an application and undergo some medical testing. On occasion, group plans may offer a limited benefit amount to which you can secure coverage with only answering a few short questions (known as simplified underwriting). These offers cannot be made frequently, so you may want to consider them when you receive one.
Disability insurance can be confusing, but it’s coverage that most of us should consider. After all, how many of us could afford not being able to work while incurring medical bills? Feel free to message us if we can answer any additional questions about disability insurance.