If you got disabled and could not work, how long would your money last? Most people roughly understand the value of life insurance, but it almost seems as if disability insurance often receives far less attention. Even though in the same situation, death or serious disability would mean a loss of the same income that provides for your household. There is an argument that even more income is required for people with disabilities compared to before. So why is disability insurance less common than life, auto, or home insurance? How important is disability insurance?
Key Takeaways
- Disability insurance helps replace income if you are permanently injured and can no longer do your job. According to the CDC, 24%-29% of Americans have a disability.
- Because jobs vary in the degree to which a disability qualifies for coverage, occupational definitions determine whether you qualify for your own policy and the terms of that policy.
- If your emergency fund cannot cover your income for 3-6 months, consider short-term disability. If your assets won’t cover your expenses long-term, you may also need to consider long-term disability insurance.
Life and Disability Insurance
In theory, both life and disability insurance solve the same problem: income replacement. Life insurance covers the risk of your passing, whereas disability should cover the risk of a disability keeping you from working. It would seem ironic for your household to get a check if you died in a car wreck, but not get a check if you were permanently injured and required support.
What Does Disabled Mean?
Life insurance is pretty straightforward. When you pass away, your family gets the proceeds. Disability insurance, however, can be more nuanced since the degree to which a disability could qualify for benefits could be infinite. Imagine a surgeon who damaged their hand, or a truck driver who could no longer drive. These definitions of occupations will be very important to review for each policy and can dramatically change whether you qualify for your own policy.
Short Vs. Long Term Disability
The eventual goal is to become financially independent enough that you do not need either short-term or long-term disability coverage. Even if you are not fully there, your current level of assets would help to answer this question. If your emergency fund and/or savings cannot cover your income for the next 3-6 months, then look at short-term disability. If your assets cannot cover your expenses for the “long term” or “indefinitely”, then long-term disability may be needed as well.
Don’t Rely on Other Programs
There are two main social disability plans that everyone can potentially access: Workers‘ Compensation and Social Security Disability Income. According to New York Life, only about 3% of disabilities are caused on the job. Which means for most people, workers’ comp is not sufficient to provide the income relief that you may expect from any disability. Social Security Disability, on the other hand, requires total disability, and rejects on average about 68% of claims. Chances could be pretty good that neither program can help if you were to become disabled but did not qualify.
How Much Disability Insurance Do You Need?
While it will vary widely, most disability policies look to cover about 60%-70% of your monthly income. Remember, if you became disabled, 60% of your income beats 0%. Your current level of income likely includes paying 15% to potentially 35% in taxes, so in theory, those taxes would be reduced after you stop working. The goal for the disability policy would be to provide close to the same net income you live on now.
Disability Payments Are (Usually) Tax-Free
One of the benefits of disability payments is that they are tax-free, as long as you paid the policy yourself beforehand. Those who got disability insurance through an employer that took it out of their paycheck may still have to pay taxes on that income. The tax status is specific to the funds you used to pay for the premiums initially. If you used pre-tax dollars through your employer, the government would want to tax the income. If you used your bank checking/savings (after-tax money), then the future disability checks would not need to be taxed again.
How Much Does Disability Insurance Cost?
It is hard to estimate a broad cost since these policies vary so wildly based on different definitions, elimination periods, riders, benefits, etc. Similar to life insurance, it can be a good expectation that a few hundred dollars a month will go towards the disability policy. It is worth shopping around with an independent agent to see what may be best for you.
Is It Worth It?
Bottom line, you are buying another insurance policy with the hopes that you never need it. But do not think that disability is a problem not worth solving. According to the CDC, 24% of people aged 18-44 have a disability, and 29% for those aged 45-65. If you became part of that group, would your current financial resources be enough to maintain your household? There are tradeoffs to every financial decision, so see if disability insurance is worth it for you.
TC Falkner 