Disability insurance may seem like an unnecessary expense — one more layer of protection you don’t really need. However, when considering all forms of insurance, it’s wise to ask yourself, “What if?” In this case, what if you lost your income stream, which is arguably your most valuable financial asset. Without it, how would you pay for your home, food, clothing, and all the rest?
The degree to which your income comes from paid work (as opposed to investment income) is the degree to which it is worth considering disability insurance. If illness or an injury made it impossible for you to do your job for an extended period, a disability policy would replace a portion of your income.
Could it happen to you?
If you’re young and healthy, you may dismiss the chances of becoming disabled, but consider the following.
According to the Social Security Administration, about one in four 20-year-olds will become disabled before age 67.
According to the Council for Disability Awareness, most disabilities are not due to work-related accidents. Primarily, they’re due to illnesses — such as cancer, heart disease, and diabetes — but also back pain, injuries, and arthritis.
Still, before allowing such statistics to scare you into potentially overpaying for protection, think about the coverage you may already have.
Short-term disability policies typically replace most, if not all, of your base income for three-to-six months. Here’s how you may already be protected.
An Emergency Fund
If you have six months’ worth of essential living expenses in a savings account “emergency fund,” you’ve effectively insured yourself against a short-term disability.
State Disability Programs
Five states — California, Hawaii, New Jersey, New York, and Rhode Island (and the Commonwealth of Puerto Rico) — have short-term (six months) disability insurance programs. Fourteen states — California, Colorado, Connecticut, Delaware, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Oregon, Rhode Island, Vermont, and Washington (as well as Washington, D.C.) — have or will soon have paid family and medical leave (PFML) insurance programs. The programs, paid for by mandatory employee payroll deductions or voluntary employer payments, pay a portion of an employee’s salary if they cannot work due to illness, injury, or other reasons. The benefit period varies by state.
Does your employer allow you to roll over any unused personal days? If so, and if you keep some in reserve, they could help cover a short-term disability. Some employers also have programs in which employees can donate unused paid time off to co-workers.
Several years ago, a friend who lives in California was stricken with bone cancer. During the eight months he was out of work for treatment, much of his income was covered through a combination of the state’s short-term disability insurance program and paid time off donated by co-workers.
What if an illness or injury prevents you from working for longer than six months? That’s where long-term disability insurance comes in, typically covering 60-80% of your base salary, potentially up to age 67. There are two forms of long-term disability coverage you may already have, but qualifying for them can be difficult.
If you suffer a disabling work-related illness or injury, workers’ compensation insurance is designed to replace some of your salary. All states require employers to provide this coverage. It typically pays about two-thirds of your pre-disability income. However, according to the National Safety Council, the majority of long-term disabilities come about from non-work causes and therefore wouldn’t qualify for workers’ compensation.
Depending on how long you’ve contributed to Social Security, you may qualify for disability benefits. (To find out, go to SSA.gov.)
However, the Social Security Administration (SSA) uses a strict definition of disability (you have to be unable to work “due to a severe medical condition that has lasted, or is expected to last, at least one year or result in death”) and a broad definition of employability (the condition has to prevent you from doing any substantial physical and/or mental activities for pay). Only the most severely disabled are supposed to qualify.
Processing an application for disability benefits can take three to six months, and the SSA says more than 60% of initial applications are denied. For those who do qualify, benefits tend to be modest. In 2022, the average monthly disability payment was $1,358.
Buying more protection
If there’s a gap between your need for disability insurance and the coverage you already have, see if your employer offers a group plan. Typically, a group plan will be less expensive than buying an individual policy.
Keep in mind that such coverage probably will not be portable. If you leave your employer, you’ll lose your coverage. Also, if you are a high-income earner, understand your policy’s limits. Normally, a group long-term disability policy will replace 50-60% of your base salary up to a monthly cap that may be far less than your current monthly income.
If you decide to shop for an individual policy, whether to supplement a group plan or because your employer doesn’t offer coverage, here are key factors that will affect the price.
This is the amount of time before benefits begin after a disability. A typical waiting period is 90 days, but a longer waiting period, made feasible by a healthy emergency fund, will lower the cost of the policy.
You can choose a policy that will pay benefits up to age 67 or 65, or for a more limited period, such as two, five, or 10 years. Policies with shorter benefit periods cost less.
Just because you qualify for a certain monthly benefit doesn’t mean you need to apply for that much. If you have other sources of income, you may only need a lesser amount.
Some policies use a broad definition, such as the inability to work any job you are qualified for. Some define it more narrowly, such as the inability to perform your current job. While it’s the more expensive option, you’ll probably want an own occupation policy, which pays if you’re unable to perform the “material and substantial duties of your own occupation.”
Among the various add-ons available, you may want to consider an inflation rider, which adds an automatic cost-of-living increase to the monthly benefit each year. You may also want protection in case you can’t work full-time, but you can work part-time. A residual disability benefit rider would pay a portion of the difference between your new lower income and how much you used to make.
Where to purchase
If you decide to buy disability insurance, talk with people you know who have coverage and ask if they’d recommend working with the agent or company they used. Online providers are available as well. Two recommended by The Wall Street Journal are Policygenius and Disability Insurance Quotes.
As we’ve counseled when writing about long-term-care insurance, your choice is not just between carrying a full-featured policy and no policy at all. You could pick up some disability coverage, perhaps opting for a policy that would pay benefits for just five years, for example. After all, according to the Council of Disability Awareness, three years is the average length of a long-term disability claim. That may be a cost-effective way to take at least some of the financial sting out of a disability.