A disability can cripple a person’s ability to work and earn a living. It also can maim a family’s financial plan more than a death of a bread-winner, because the disabled person still has living expenses to pay, plus the medical bills necessary for his or her care.
One way to counteract this is through disability insurance. But disability insurance is not typically a high priority when making a financial plan, because most people don’t think they need it.
In 2010, about 19 percent of the U.S. population — nearly 57 million people — were living with a disability, according to the U.S. Census Bureau.
About 40 percent of those disabled Americans were in their prime wage-earning years, from 18 to 64. The Social Security Administration projects that one in four of today’s 20-year-olds will become disabled before age 67.
Cathy Pareto, a certified financial planner, sees disability insurance as an essential piece of the financial-planning puzzle, along with saving for retirement or college, and creating an emergency fund.
“You have to think about the possibilities of the unknown. You have no idea what medical condition you could be in in 15 or 20 years. What if you have a debilitating heart attack or a stroke, and you can’t walk, or write, or speak?” said Pareto, president of Cathy Pareto and Associates in Coral Gables. “It’s the only real way to safeguard against those possibilities. I see it as one of the basic building blocks of a sound financial plan.”
There are three basic types of disability insurance: employer-sponsored plans, private individual insurance, and government-sponsored plans, such as Social Security disability.
A common misconception is that Social Security will automatically take care of you if you become disabled, said Ron Reshefsky, chairman of Century Risk Advisors in Coral Gables and Boca Raton. But it’s difficult to get approved, he said. According to the Social Security Administration, about 65 percent of initial Social Security Disability Insurance claims were denied in 2010.
Another misconception is that most disabilities are caused by accidents, said Wayne Green, a certified financial planner and regional manager of CPS Insurance in Boynton Beach. Most disabilities occur because of illness, he said.
Reshefsky said a disability that interferes with your wage-earning potential can be a life-changer in more ways than one.
“If you don’t have the wages to do things like make investments or prepare for retirement, you’re not going to be able to afford it, because you’ve lost your income,” he said.
The more money you make, the more disability insurance is necessary, Green said.
Check with your employer to find out what disability insurance it offers. If you have none or it’s not enough, get quotes on long-term disability.
Short-term coverage typically only covers you for 60 to 90 days, which you should be able to manage on your own with an emergency fund. “Short-term disability is not that expensive, but if you’re a decent saver, that is your short-term disability. Should you really pay extra for that?” Pareto said. “Long-term disability is what you need to think about.”
Long-term disability insurance premiums will depend on things like your age, health, previous injuries, whether you smoke, and the amount of income you’re trying to replace. The type of work you do affects the premium, because a white collar office worker can get a better rate than a construction worker who is out in the field and has more exposure to an accident, Green said.
The four factors that most affect your premium rate are the elimination (or deductible) period, the health of the individual, the monthly benefit, and the time period in which the claim will be paid, Reshefsky said.
Here’s one example: A 37-year-old male physical therapist with “own occupation” coverage for five years, a 90-day elimination period, maximum monthly benefit of $4,000, and coverage to age 65 has a base annual cost of $2,839. A cost-of-living-adjustment option adds $400. A residual benefit to transition him back to full-time work adds $740.
“Any additional bell or whistle you add is going to cost you money. These policies are not cheap,” Pareto said.
Here is a look at some options in a disability insurance policy:
Length of policy
Everybody’s definition of long term is different, Green said. Some say five years, some say 10. “I say to age 65 because you don’t want to become disabled and use up the money you put away for retirement,” he said.
A lifetime benefit is not as prevalent as it used to be, Green said. And lifetime benefits may decrease as you age, depending on the policy and when you become disabled.
Pareto recommends buying until “at least age 65, when other benefits kick in.”
Reshefsky said he recommends lifetime benefits. “If you’re a wage-earner, you will need those benefits for the rest of your life. If it stops at 65, you have to change your lifestyle.”
A caveat: Insurance companies will typically only honor lifetime benefits if you become disabled before the age of 60, he said.
“You want to buy at least to 65. It’s more expensive to buy lifetime, but if it’s an individual policy, we strongly recommend it,” Reshefsky said. “Depending on when you buy coverage, that lifetime benefit could cost about 10 percent extra in premium.”
How disability is defined
“Read the fine print,” said Pareto. “The way you define disability may not be how the insurance company defines it.”
Some policies define disability as not being able to do your job, or “own occupation.” Other policies define disability as not being able to do any job, or “any occupation.” Policies with “own occupation” coverage are more expensive, but are preferable depending on your job, Green said.
For example, if you are a surgeon, you want “own occupation” coverage for the life of the policy, he said. “Say you can’t be a surgeon anymore because something happens to your hands,” Green said. “You may still be able to teach. ... Having ‘own-occupation’ coverage means that you can earn money as a teacher, but not lose your disability benefit.”
Most policies start out with one or two years of “own-occupation” and transition to “any occupation,” he said.
If it’s not defined as own occupation, then your claim can get denied, Pareto said. “They can say ‘You can flip burgers at Burger King, so you’re not disabled.’ ”
Own-occupation coverage is critical, especially for professionals, Reshefsky said. “The rise in premium is negligible because professionals are considered a better risk,” he said.
The standard is 40 to 60 percent of your taxable income, depending on your earnings, Green said. To decide how much you need, look at other sources of income. Today, there are usually two incomes in a household, Green said, so look at your spouse’s earnings, and determine your monthly expenses.
“Some people look at savings as their income source,” Green said. “But if expenses incurred while disabled are above your typical living expenses, you don’t want to divest yourself of all your savings, and then not have anything to live off of in retirement.”
Pareto said to determine your personal bottom line. “If you are unable to work for an extended period of time, or forever, would you be able to survive on 60 percent of your income? Probably not,” Pareto said. “Shoot to cover 100 percent of after-tax income.”
This option will adjust your benefits for inflation.
“You’ll spend more for this option, but it’s important, depending on your age,” Green said. “The younger you are, the more important it is. The older you are, the less important it becomes.”
Residual or partial benefits
This option pays you a partial benefit if you are not fully recovered and want to work part-time. “It certainly helps you if you’re trying to get back to work, and there is a period of time when you’re not 100 percent disabled anymore,” Reshefsky said. “Most individual carriers today include residual coverage.”
Transition benefits can help those in certain jobs, such as commission-based work, Green said. A salesman who is disabled for six months may get 100 percent better and go back to work, but his income is way down. Transition benefits can help make up the gap as income grows to pre-disability levels.
Non-cancellable or guaranteed renewable
A non-cancellable policy has set premiums for life. A guaranteed renewable policy’s premiums can be raised by an insurance class, but not by an individual’s circumstances.
Non-cancellable policies start off more expensive, Green said, “but we’re not really talking a large increase,” he said.
“Non-cancellable is the most beneficial feature of an individual policy,” Reshefsky said. “If I’m 25 years old and just entering the workforce, and can buy a policy, I don’t have to prove insurability again.”
An elimination, or deductible, period of 60 to 90 days is the most popular. A 30-day period is much more expensive, Green said.
“If a person has an emergency fund, which everyone should have, they should look at the premium and ask themselves, ‘How much more am I paying to self-insure for 30 days?’ ” Green said.
Reshefsky recommends buying the longest elimination period you can afford. “The higher the elimination period, the lower your premium,” he said. “It’s like buying a health-insurance premium with a $5,000 deductible, instead of a $500 deductible. Your premium will be lower.”
Taxed vs. tax free
With disability, it depends on who is paying the premium, if your company is paying the premium through a group policy, the benefit is taxable, he said. If you pay the premium, the benefit is tax-free.
“Sometimes, employers will give you the option of having the premium they pay for you classified as your income,” Green said. “And if they don’t mention it, ask if it can be done.”
The big picture is risk management, Pareto said. “How much good does it do to plan for retirement, if it’s all going to be sucked up by some unforeseen accident that leaves you unable to support yourself financially?” Pareto said. “This fills in the holes — the unknowns that could sabotage the best financial plan you could ever assemble.”