Disability insurance is one of the most important financial tools that a young professional can own. It is so important that when my now-wife and I began discussing our finances, it was the first topic on our list.
The reality is that, for the overwhelming majority of us, our ability to earn an income is our largest asset. It is that income that allows you to live the life you hope to live. But what happens if you are no longer able to work? How will you save for retirement or educate your children, let alone put food on the table and make your mortgage and student loan payments? Enter disability insurance.
Disability insurance provides you and your family with financial security, replacing your income in the event that you are unable to work due to an injury or illness. Monthly benefits can continue for as long as you are unable to work – potentially years or decades.
While it sounds pretty straightforward, as you probably guessed from the title of this post, it isn’t.
Before diving into the specifics of an individual disability insurance policy, let’s first review some important facts:
- According to the Social Security Administration, more than one in four adults will become disabled for at least one year during their working years (ages 20 to 67).[1]
- While most people think of disability as being caused by accidents, the overwhelming majority (approximately 90%) is caused by illness.[2]
- Though many employers offer long-term disability benefits, this coverage may not be enough – especially for doctors, dentists, lawyers, and other highly-trained professionals. These polices are generally capped at a certain amount of income and many will only cover you in your occupation for two years.
The Specifics
The most important aspect of any disability insurance contract is the definition of disability. A True Own-Occupation Definition of Total Disability will consider you disabled if due to injury or sickness, you are not able to perform the material and substantial duties of Your Occupation. Certain professions, such as physicians and dentists, should insist that that their policies include this definition.
Consider an orthopedic surgeon, for example, who develops a tremor in her hand. She suddenly finds herself unable to work in her specialty, a specialty she spent almost ten years training for. Even though she can no longer work in her chosen field, there are any number of positions she can still pursue, although likely not with the same income potential. Assuming her disability insurance policy includes the true-own occupation definition of total disability, she will collect her tax-free disability claim each and every month in addition to her salary in her new profession.
What happens if you are not totally disabled? Will the policy still cover you if you lose only a part of your income? While each company refers to the rider by a slightly different name, the Partial Disability Benefit Rider is designed to protect against this risk. In the event an accident or illness causes you to lose some (but not all) of your income, this rider will pay you a proportional benefit and ensures that your overall income is protected. For example, consider a dentist who owns a disability policy with a $10,000 monthly benefit. If he is injured in a car accident and, due to severe back pain, cannot practice as efficiently as he did prior to the accident, his income is going to decline; possibly drastically. Assuming he suffers a 60% loss of income as a result of the accident, he would receive $6,000 in tax-free disability benefits until he recovers and brings his income up to pre-disability levels.
The next question is when do benefits begin and how long will they be payable in the event of a disability. The Elimination Period is the period of time during which you are disabled before benefits are payable. The elimination period on most individual disability insurance policies is 90 days, although you can select either a shorter or longer period. As the elimination period increases, the required premium will decrease. The Benefit Period is the maximum period that benefits can be paid to the insured, typically age 65 or age 67. Most professionals elect to be covered through their full retirement age; it just does not make sense to trade a career’s worth of income for a 10-year benefit period.
Policy Riders
A rider is an additional benefit that can be added to a policy in exchange for an additional premium. Disability insurance riders enable us to tailor a policy to meet the specific needs of our clients. The most common disability insurance riders are:
- Partial/Residual Disability: As stated above, the Partial Disability Benefit Rider is so important that I talk about it as a core element of a disability insurance policy. This rider allows you to receive a proportionate benefit if you have a partial loss in income. Absent this rider, a disability insurance policy would only compensate you in the event you are totally disabled.
- Future Increase Option (FIO): As your income increases, the FIO guarantees your ability to increase your monthly benefit without having to go through medical underwriting. This rider is exceptionally important since it removes the medical underwriting risk as we age. For professionals who expect their income to rise significantly in the future, the FIO should be an essential component of their disability insurance coverage.
- Cost-of-Living Adjustment (COLA): Each year that the insured is receiving disability benefits, this rider will increase your benefit by a certain percentage annually, so that your benefits keep pace with inflation.
- Student Loan Rider (SLR): For those who have significant student loans, this rider will provide an additional benefit – up to $2,500 per month – on top of the insured’s monthly benefit. As the name suggests, these funds are meant to cover qualifying student loans in the event of a disability.
- Retirement Protection Plan (RPP): While a disability insurance policy is designed to protect your income, it may be difficult to save for retirement if an accident or illness requires that you pursue another profession. This rider (issued as a separate policy in some states) will provide an additional monthly benefit designed to help you save for retirement.
- Catastrophic Disability (CAT): If your disability is so extreme that you require assistance in your daily life, this rider will provide an additional benefit to help offset those costs.
As you can see, the intricacies of a disability insurance policy are complex. Polices that appear to be the same on their face may not include the same important benefits or features. It is critical that you understand your policy and make sure that it effectively addresses your needs. You may wish to consult with an independent advisor who understands the disability insurance market and is able to provide you with a detailed analysis.
[1] Maleh, Johanna & Bosley, Tiffany. Disability and Death Probability Tables for Insured Workers Born in 1999. Actuarial Note 2019.6 prepared for U.S. Social Security Administration. Baltimore: Office of the Chief Actuary, 2019.
[2] National Institute of Mental Health.
https://www.nimh.nih.gov/health/statistics/disability/us-leading-categories-of-diseases-disorders.shtml