What is disability insurance?
Disability insurance replaces income if an employee becomes ill or injured and can no longer work. Like with life insurance, individual and group (employer-sponsored) policies exist. Here we discuss the general qualities of disability policies.
Benefits of disability insurance
Disability insurance coverage may provide several benefits, including:
-Replacing most income
-Preventing the erosion of amassed assets
-Helping pay medical bills while you are not working
Importance of disability insurance
If you regularly read my blog posts or view my videos, you likely have seen a discussion of Personal Benefit Buckets. Workers must realize that the buckets do not produce equal amounts of benefit. For example, a younger worker must protect his or her capacity to produce income by working. This working potential is the largest asset owned. If this potential drops, the worker must have a replacement in line to help cover any lack of income – thus, the importance of disability insurance.
Also, the odds of a 35-year-old worker using disability insurance before life insurance before age 65 are 3.5:1 (4.) This statistic reflects the same concern of Gen X and Gen Y. In fact, 70% of Millennials and Gen Xers worry about disability as a financial concern (8.) However, only 33% of employed consumers have disability insurance (8.)
Below, the discussion continues with details about and terms of many disability policies.
DISABILITY TERMS AND CONCEPTS
Occupational vs. non-occupational
Occupational coverage applies to injuries or illnesses related to the job, while non-occupational coverage is not related to one’s work. The former may constitute coverage originating from multiple sources, like a group disability plan through the employer or an individual policy and government programs such as Workers’ Compensation or Social Security.
Non-occupational and occupational coverage should not be confused with own-occupation versus any-occupation terms. Own-occupation and any-occupation as described by MyLTDBenefits.com:
An own occupation policy typically needs the insured to be unable to perform the material and substantial duties of his or her particular occupation to be considered “totally disabled.” The disability need not render the claimant totally helpless; rather the claimant must be rendered unable to perform the material and substantial duties of his or her particular occupation…an “any occupation” standard to qualify for disability benefits. These policies typically define disability in terms of the insured’s inability to engage in any gainful occupation that the insured is reasonably suited for based on his or her education, work experience, and other individualized factors (1).
Group disability policies may start providing benefits under an own-occupation provision and later move to an any-occupation (1).
What is an elimination period?
Think of an elimination period as a deductible. This is the time period after the illness or injury during which benefits are not paid. The longer the elimination period, the lower the premium is. The period may be a few days to 30, 60, 90, or 180 days.
Depending on the time period, coordinating your emergency fund to help cover expenses during the elimination period is a great practice. There are, however, circumstances in which this may be difficult. An example is a person who has landed his or her first job but who has not yet saved enough money to cover three to six months’ worth of living expenses.
Short-term versus long-term
Disability insurance will be either a long-term policy or a short-term policy. While the classifications suggest differences in time, this comparison will review more information.
Short-term disability policies are normally provided only through employers. A few states (California, Hawaii, New Jersey, New York, and Rhode Island) require employers to provide such a benefit (2). The benefits coverage may start a few days after the illness or injury and will last only a few weeks to a few months. Because the coverage duration is short, premiums are affordable. Workers may also use sick or vacation time and emergency savings to accompany short-term policies. (Please speak with your HR department for more information.)
Long-term disability policies are more important from a planning perspective, as the duration of coverage may last from months to years. This makes such policies more expensive than a short-term disability product. The elimination period – the time during which benefits are not paid – may be anywhere from 60 to 180 days. During this period, the employee must provide the means to cover expenses. Individual long-term policies may be customized to suit the specific needs of the person.
How much coverage do I need?
Like life insurance, a host of factors influences the coverage needed for a disability policy. The general idea, however, remains the same in terms of managing risk: replace the income lost because of the inability to work. Start by gathering your monthly outlays and add retirement account contributions, philanthropic giving, and health insurance premiums. Next, evaluate coverage provided by your employer. If the employer does not provide coverage, seeking an outside policy may make sense. Third, look for ways to cover a shortfall. This may depend on other income sources available. For example, a worker who is close to retirement may not need as much coverage because of his or her access to income sources like Social Security or a pension. Online calculators exist to help discover coverage gaps.
Also, private policies are more expensive than group policies; premiums are influenced by health, age, income, and terms of the policy.
Incorporating employer disability insurance into your financial plan
Depending on the time period and coverage of a short-term disability policy, coordinating your emergency fund to help cover expenses during the elimination period is a great practice. There are, however, circumstances in which this may be difficult. As previously noted, a new young worker starting her career or a worker who has little to no savings may not be able to bridge the gap.
Another technique involves using other benefits to cover short-term needs before the long-term coverage benefit begins. For example, use vacation or sick time as a possible funding source. The benefit will be complete coverage of your salary, but taxes may be taken out.
Taxation of disability benefits depends on who pays the premium and whether it was with pre- or post-tax dollars. Individual policies normally bought with after-tax money, making the benefits nontaxable. However, employer-sponsored group plans may be different. If the employer pays the premium or a portion of the premium that is not included in the employee’s taxable income, the benefit becomes taxable. Any portion of the premium paid by the employee with after-tax dollars will create a nontaxable portion of the matching benefit (3).
- Evaluate how much coverage you need.
- Examine your current disability coverage and see if a shortfall exists.
- If a shortfall does exist, can you buy extra coverage through your employer? If so, how long will it be before your benefits enrollment period opens? Contact your HR department for more information about policy details, or contact me for planning questions.
- Examine outside policies, if needed.
- Call me at 317-805-0840 with financial planning questions and to help coordinate your work benefits.
- “Own Occupation v. Any Occupation.” com. Alan C. Olson & Associates, 2011-2016. Web. 5 Mar. 2016.<http://getmyltdbenefits.com/own-occupation-v-any-occupation/>
- Walters, Chris. “Long-term Disability vs. Short-term Disability Explained – PolicyGenius.” PolicyGenius. 2014. Web. 05 Mar. 2016. <https://www.policygenius.com/blog/long-term-disability-vs-short-term-disability-explained/>.
- “Taxation of Disability Insurance.” Financial Planning Advice and Financial Advisors. Ameriprise Financial. Web. 05 Mar. 2016. <https://www.ameriprise.com/research-market-insights/tax-center/tax-planning/taxation-of-disability-insurance/>.
- “Death vs.Disability” AffordableInsuranceprotection.com. 06 Mar. 2017. <http://www.affordableinsuranceprotection.com/death_vs_disability>