What is disability insurance?
Disability insurance (also known as DI) is an insurance product that will pay you a benefit if you are disabled due to an illness or injury and unable to work.
Disability is one of the leading causes of financial challenges, including bankruptcy. While Workman’s Compensation (also referred to as workers’ compensation) covers some injuries, others, such as a car wreck outside of work or an illness like heart disease, cancer, or Alzheimer’s, are not covered. Therefore, it is essential to a financial plan.
The different types of disability insurance
There are four main types of disability insurance: short-term, long-term, Social Security Disability Insurance (SSDI), and Supplemental Security Income (SSI).
What is Short-Term Disability Insurance?
Short-term coverage pays you a portion of your income for a limited time – typically 90 to 180 days after you are disabled or become ill and unable to work. The payments generally begin shortly after the disability.
The policy pays a percentage of the person’s salary, up to a maximum amount, and is designed to replace lost income due to a short-term disability.
What is Long Term Disability Insurance?
Generally, long-term disability income insurance covers injuries and illnesses that last longer than 90 to 180 days. The policy pays a percentage of the person’s salary, up to a maximum amount, and is designed to replace a portion of lost income due to an inability to work.
The company will begin paying once your elimination period ends. A typical elimination period is 90 days. If you become disabled and cannot work, your benefits will not kick in until 90 days have passed. After that, you will begin receiving benefit payments.
The shorter your elimination period, the more expensive the policy.
The time your policy will pay you will depend on the term you select, i.e., a few years versus your working lifetime. The younger you are, the greater the need for coverage to last your entire working years.
Without income, you may be unable to pay your bills or fund your retirement plan. Once you are much older, have saved, and established yourself, it is possible to have a policy with a shorter payout (i.e., 5-10 years).
Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI)
Both SSDI and SSI are government-sponsored programs. They assist people who cannot work due to a disability.
To be eligible for SSDI, a person must have worked and paid Social Security taxes for a certain period. To qualify for SSI, a person must have a limited income and resources.
There are also several types of private disability insurance policies available. DI policies vary in terms of coverage and cost. Some employers also offer disability insurance as a benefit to employees.
The Cost of Disability Insurance
As with all types of insurance coverage, the better the coverage, the more expensive the premium. Factors like age, health, and medical conditions also affect the cost.
The older you are, the more expensive the coverage. The cost increases each year as you age. DI also tends to cost more for women than men. So, the sooner you get coverage, the less it will cost.
Two primary features affect the cost of the coverage. These include the length of the elimination period (how long you must wait to receive money) and the duration you receive benefits (the payout).
The shorter the elimination period, the higher the potential payout for the insurance company, and thus, the more the policy will cost.
How much disability coverage do I need?
This is a common question. First, determine how much money you make each month. Then, subtract the coverage you have through your employer (if applicable).
Next, determine how much of your take-home pay you need to afford your essential monthly expenses. This is the minimum amount of income you need to insure.
If you earn $75,000 per year in salary, you will earn $6,250 monthly ($75,000/12=$6,250).
Assuming you have $18,000 of DI coverage with your employer, you would have $1,500 per month ($18,000/12 = $1,500).
If your minimum expenses are $5,000 per month, you would need disability coverage equal to $3,500 per month.
You would need $3,500 of additional coverage: $5,000 (expenses) – $1,500 (DI with employer) = $3,500 (need).
The average disability insurance policy purchased equals about 60% of current income.
In the above case, $75,000 x 60% = $45,000. This is very close to the $42,000 of recommended coverage ($3,500 x 12).
Purchasing insurance is a critical decision, so always consult with a qualified advisor and review your entire financial situation before deciding.
How Disability Insurance Works
Insurance products protect against a loss. For example, your homeowner policy will reimburse you if your home burns down. Life insurance will protect your loved ones if you die prematurely. Disability insurance pays you to replace income lost because you cannot work due to illness, disease, accident, or injury.
If you are disabled and unable to work because of the disability, your coverage will compensate you for a portion of your loss of income.
What Insurance Do You Get with Social Security Disability?
The Social Security System has possibly the strictest requirements for applicants.
They must prove that their disability is expected to last for at least 12 months or that it is expected to result in death.”
For this reason, most experts recommend that you do not plan on receiving social security benefits and that you instead purchase a private disability insurance policy.
A person is considered disabled if they cannot perform the duties of their specific occupation before they become disabled.
Any occupation means a person is considered disabled and cannot perform the duties of any job (This includes flipping hamburgers at a fast-food restaurant!).
This is the time that must pass before benefits are paid out under a disability insurance policy.
This can be anywhere from 30 days to several years, depending on the policy. Once you have become disabled and the elimination period has passed, benefits will begin to be paid out.
The amount of money you will receive from your insurance company if you become disabled and cannot work.
Cost of Living Rider
This allows your benefit to increase to keep pace with inflation.
The insurance company will not pay benefits for a disability under certain conditions. Examples include a self-inflicted injury, driving under the influence of drugs, or competitive racing.
Summary – What is Disability Insurance?
The benefits and features change depending on the company and product. It is advisable to review the options with a qualified advisor who can help you determine the best policy and coverage.
In conclusion, protecting you and your family if you become disabled is critical to a successful financial plan.
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