While many consumers consider life insurance to be one of the staples of their personal finances, many of them tend to overlook the risk of becoming unable to work for an extended period of time. This is unfortunate, because statistics show that it is several times more likely that someone will become disabled for a period of time before they retire than it is that they will die prematurely. In fact, the Social Security Administration has stated that a whopping quarter of all workers aged 20 today will become disabled for a period of at least 90 days at some point in their lives.
A period of disability can be far more disastrous financially than premature death. If someone dies, then there may be some medical and funeral bills to pay, but that is the end of it. When someone becomes disabled, then their income is cut off, but they may need professional care for a period of months or years. Families who are caught in this vice can easily find themselves having to declare a medical bankruptcy in order to deal with the bills racked up by the disabled person. Disability insurance can provide the coverage you need in order to ensure that if you get laid up for an extended period of time, then your ability to earn a living will be protected.
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How Disability Insurance Works
Disability coverage is one of the simpler forms of insurance available to consumers today. Basically, if the insured becomes disabled and unable to work and they are current on their disability insurance premiums, then the policy will kick in and make a monthly payment to replace their income. If the policy is a short-term disability policy, then the policy may pay benefits for up to two years. However, long-term policies may continue payments until the insured reaches age 65. The length of the waiting period effectively serves as the deductible for the policy. Short-term disability policies usually have waiting periods of 15 to 30 days, while long-term policies usually don’t start to pay out until at least a year or two of disability has elapsed.
Types of Disability Insurance
There are several ways in which disability insurance policies can be classified, such as long and short-term. Another way that they can be grouped is by the amount of coverage that they provide on a monthly basis. Some disability policies, known as own-occupation policies will begin paying out if the insured becomes unable to perform the duties of his or her own occupation. Of course, this type of coverage is more expensive than any-occupation policies, which will only pay out if the insured becomes completely unable to work any type of job. For this reason, highly paid professionals and executives usually purchase the former type of coverage, while lower-paid workers often settle for the latter. You can imagine how hard it would be for a doctor or dentist to have to settle for coverage that would not pay out a benefit if they became unable to perform the duties of their own professions, but could still work a job in the fast food industry. There is also residual disability insurance that can pay out a partial benefit if the insured can still perform their duties at least part-time or work a lesser job in their field of occupation. Some long-term disability policies will also pay insureds for additional training that they may need when the return to the workforce.
Disability insurance also differs from other types of coverage such as Workman’s Compensation, which will only pay out if the insured is injured on the job. But private disability insurance provides round-the-clock coverage for the insured and will also usually pay out in the event of a major illness, such as cancer or heart disease.
Taxation of Disability Insurance
The tax rules for disability insurance are very simple. As long as the insured did not deduct the cost of disability premiums on their tax return, then the payments are unconditionally tax-free. If they did deduct the cost of premiums on their taxes, then payments will be taxed as ordinary income, meaning that they will be taxed at the insured’s top marginal tax bracket. For this reason, most financial planners and insurance agents and brokers caution their clients against deducting this expense.
Amount of Coverage
Because the insured will receive a tax-free benefit from their policy if they didn’t deduct the cost of the premiums paid, most financial planners and insurance agents tell their clients that they only need a level of coverage that will pay a monthly benefit equal to 60-70% of their previous earned income. This will roughly replace the after-tax income of the insured in most cases. Most disability policies also have a cap on the dollar amount that they will pay, such as $10,000 per month.
Cost of Disability Coverage
Disability insurance can be pricey in some cases, depending upon the insured’s health and occupation. Most long and short-term policies will cost the insured anywhere from one to three percent of their annual gross income, but short-term policies tend to cost more than long-term coverage. So for someone who is earning $50,000 per year, the premiums would run anywhere from $60 to $125 a month. However, some employers offer short-term coverage as a free benefit for their workers and then offer additional voluntary long-term coverage at the employee’s expense on top of that.
As with life insurance, disability policies are usually cheaper when they’re offered through an employer. But the catch is that if an employee works for the same employer for many years and then changes jobs, then reacquiring disability coverage may be difficult if the employee’s health has declined. Standalone individual policies can guard against this possibility, especially if they have a “non-cancellable” clause, but they usually cost more than group coverage. But the higher premiums may be worth it, especially if the insured works in a potentially hazardous occupation such as construction.
You can also explore any offerings that are available through any professional associations that you belong to, because many of them also offer this type of coverage at discounted rates. The factors that affect the amount of premium that you pay for disability coverage include age, gender, income, the length of the waiting period, the length of time that benefits will pay and ancillary factors such as cost-of-living riders that keep pace with inflation.
What Isn’t Covered
Although disability insurance can replace your income, it doesn’t pay for certain types of expenses such as medical bills or long-term care. Most long-term policies also don’t cover pregnancy, unless the insured has complications that extend beyond birth and had the policy in place before she became pregnant. Some short-term policies do cover pregnancy, but the insured may have to wait for several weeks before benefits start paying out.
Disability insurance should be one of the cornerstones of most consumers’ finances. Those who fail to carry this type of protection do so at their own risk. Most financial planners and insurance agents tell their clients to only carry long-term disability insurance in order to reduce the cost of this type of coverage. Many of them say that it’s better to have an emergency fund handy with 3-6 months of income saved up than to pay for short-term coverage. Consult your financial advisor or life insurance agent or broker for more information on the various types of disability insurance and which type or types is right for you.