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Disability Insurance Basics

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Disability Insurance BasicsI had a co-worker a few years ago who, despite being extremely fit, was suddenly diagnosed with a brain tumor.  She had to go on long term disability for a lengthy period of time.  Fortunately, she had adequate short and long term disability insurance to replace her lost wages.  Would you be okay financially if you were unable to work for months or even years?

Even if you already have both short term and long term disability insurance, let me strongly encourage you to finish reading.  There are probably a few things you should consider.

Definitions of Disability

There are various definitions of “total disability” that an insurer may use, such as:

  • The inability to execute one’s own occupation, or
  • The inability to perform any gainful occupation for which the individual is moderately suited for

Short & Long Term Disability Insurance Policies

Short term disability insurance policies generally pay benefits for the first few months an individual is unable to work.  A long term disability insurance policy generally kicks in once the short term coverage ends.

Sources of Disability Insurance

Disability insurance may be obtained from various sources:

1.  Employer Group Disability Plan

  • Generally provides benefits no matter where disability sustained.
  • Not all employers offer it
  • Policy may change from an “own occupation” to an “any occupation” definition after a couple of years of disability
  • Benefits likely won’t increase with inflation
  • Benefits may be reduced for any benefits received by Social Security or elsewhere.
  • Benefits may or may not be taxable, depending on how it is structured

2.  Individual Plan

May be used alone or to supplement a group policy.

  • Generally the definition of disability does not change during the period of disability
  • Generally provides benefits no matter where disability sustained.
  • Benefits are generally not offset by Social Security benefits
  • Plan benefits may increase with inflation
  • Greater choices and options generally available compared with a group policy
  • Benefits normally not taxable as long as premiums are paid after tax.

3.  Social Security

Social security may provide disability benefits, but the requirements are fairly rigid, and there is no knowing what will happen in the future with Social Security.

4.  Workers’ Compensation

Workers’ Comp may provide benefits to employees who incur a disability on the job.  However, many injuries and illnesses are not job related, in which case Workers’ Comp may not apply

Benefit Amount

Most long term disability insurance policies only pay 50% – 75% of an individual’s prior wages.  There are several reasons for this:

  • Some expenses may decrease during disability (i.e. no more commuting, etc)
  • Insurance providers want people to have an incentive to get back to work
  • Disability benefits may not be subject to tax

However, I know a lot of people who would be in trouble financially if they became disabled and only brought home 50% – 75% of their normal wages.  Consider the following:

  • Some expenses during disability may decrease, but probably nowhere near 40% – 50%.
  • Other expenses will likely increase during disability
  • Some people will be permanently disabled and unable to ever work again
  • Income tends to increase over the years due to raises, improved skills, and increased experience.  Disability benefits normally do not account for this.
  • Many people pay very little income tax, so receiving tax free benefits may not help much
  • Group disability benefits may not be adjusted for inflation and may be subject to tax.

Make sure you purchase sufficient coverage to preserve your standard of living should you be unable to work.  People with few assets may need much more coverage than people who may be able to partially or fully self-insure.

The Benefit Period

The benefit period during disability will vary by policy.  Some policies specify a specific term, such as 5 or 10 years, whereas other policies provide for benefits to be paid until a specific age.

Waiting Period

Many policies have a waiting period.  A waiting period is the period at the beginning of a disability during which no benefits are paid (think of it as a deductible).

Choosing a longer waiting period will decrease rates, but thought should be given to how long you can go without a paycheck.  People with a good emergency fund and food storage might be able to choose a longer waiting period and save on disability insurance premiums.

Compare Disability Insurance Rates

Rates can vary dramatically by provider.  You may be overpaying on your current policies but you won’t know unless you get multiple disability insurance quotes.

While you probably can’t get another group policy (without changing jobs that is), you could replace an unfavourable group policy or individual policy with an individual policy that is cheaper and has more favourable terms.  Procuring a cheaper rate could save you thousands of dollars over your life

Final Thoughts on Disability Insurance

  • Consider obtaining a benefit period that will pay out until normal retirement age, or about 65.
  • Shopping around for a policy could save you thousands of dollars over your life.
  • I prefer policies with the “own occupation” definition of disability; however, this does make the policy more expensive
  • I personally have both short and long term disability policies through my work.  The long term disability policy pays 60% of my salary.  Since the thought of trying to live off only 60% of my earnings does not appeal to me, I also have a supplemental individual policy that pays me about 40% of my wages.
  • I increase my supplemental coverage each year as my income increases.
  • Make sure you have read and understand your policy.  If the terms are unfavourable or the coverage insufficient, shop around for another one.
  • A cost of living adjustment rider can adjust benefits with inflation.

 Additional Information

For additional information on disability insurance (as well as other types of insurance) you might consider reading the below book:


What are your thoughts on disability insurance?  Do you have both long term and short term disability insurance policies?  Could you afford to live off of your policy benefits if necessary?  Leave a comment below!

Image: RTimages/Bigstock

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{ 2 comments… add one }

  • Mike February 13, 2013, 7:24 am

    nice article. Learned a little about disability insurance.

    Reply
    • LD February 13, 2013, 11:09 am

      Glad you enjoyed it Mike.

      Reply

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