Key Issues When Evaluating Disability Insurance Policies
Disability insurance is critical to protecting your income should you suffer an illness or injury that prevents them from continuing to work. Replacement income can provide peace of mind for folks facing the stress and uncertainties that often accompany a disability. Yet, despite the importance of maintaining financial stability, many people lack adequate coverage to defend against the risk of disability.
To help you guide you through the complexities of this important topic, we created this checklist. It covers key considerations, including:
Key policy features and definitions
Group and individual coverage options
Federal benefits
Tax implications
Key Policy Features and Definitions:
Definition of disability (own occupation vs. any occupation): The best policies use an "own occupation" definition, which means you're considered eligible to collect benefits if you are unable to fulfill the obligations of your specific job due to a disability. If your policy is for "any occupation" then you could only collect if you are unable to work at any job. Make sure that you’re aware of any exclusions that are written into the policy.
Monthly Benefit: Fairly self-explanatory, this is the amount of money you’ll receive on a monthly basis if you become disabled. A good rule of thumb is that you should aim for a coverage amount between 60-70% of your income. However, the devil is in the details. Be sure you understand how your benefit will be taxed (see below), what happens if you’re partially disabled and return to work, and whether your benefit will adjust with inflation.
Elimination Period: This is how long you would need to be disabled before you can start collecting benefits. You’ll need to be able to cover your expenses out of an emergency fund or with a short-term disability policy (if you have one) until the elimination period expires. If you have a good emergency fund, a good way to lower the premium on your long-term disability policy is to select a longer elimination period. This is the same rationale as raising the deductible on your home or auto insurance.
Term: How long will your policy pay you benefits? Typically benefits extend until you're eligible for social security, but some policies may specify a shorter term or may change the definition of disability after a period of time.
Guaranteed Renewable vs. Non-Cancelable: A guaranteed renewable policy gives you the right to renew your long-term disability coverage each year (or multi-year term) without any additional medical exams. However, the insurance company can increase your premiums due to changes in your health. Non-cancelable means that the insurance company cannot cancel or modify the policy terms, for example by raising the premiums or reducing the payouts, until you decide to terminate the policy voluntarily. Opt for a non-cancelable policy.
Group and individual coverage options
Many employers offer disability policies to their employees. These “group policies” are either included as a fringe benefit or made available through payroll deductions. The benefits are usually based on a percentage of your income, but be sure to review any caps and determine the portability of your policy.
Group policies are often more cost effective, especially for older or less-healthy individuals, since they don’t require a physical or a review of your medical history. If you are self-employed, consider seeking group coverage through a professional association or other syndicate.
If no group policy is available to you or if it doesn’t provide enough coverage, you may wish to purchase an individual policy.
Federal benefits
Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI) programs provide benefits to insured individuals (i.e., those who have adequate credits) who qualify as disabled. SSI provides benefits to disabled individuals with limited resources and income. These programs have strict eligibility requirements, and claims are frequently denied compared to individual policies. Furthermore, federal benefits alone are not likely to be sufficient.
Tax implications
Any benefit payment attributable to employer-paid premiums will be subject to taxation. Likewise, if you pay your premiums with pre-tax dollars, any benefit you receive will be subject to income taxation. However, if you pay your premiums out of pocket or with after-tax payroll deductions, disability benefits are received entirely tax-free. Therefore, it’s important to understand how your benefit will be taxed when determining how much coverage you need.
