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Disability Insurance: an Overview

When it comes to issues of health-related financial risk, the importance of disability insurance is often sorely underrated.  In reality, holding a less-than-appropriate amount of disability insurance can be just as financially devastating as purchasing the improper amount of life insurance.  However, disability insurance receives much less airtime from the financial media and other “experts”.   

What is it?

Disability insurance protects against the interruption of income due to illness or injury. Because many employers offer some form of group disability coverage, individuals may believe they have adequate coverage even when they do not. Oftentimes, employer policies reimburse no more than 50-60% of total wages or salary, which can leave a large hole in a family’s income. And while Social Security disability insurance (SSDI) does provide somewhat of a safety net, it’s important to realize that SSDI only comes into play when illnesses or injuries are expected to last for more than one year. In addition, approximately 65% of the applications for Social Security disability are denied.  

How do I obtain it?

Because some studies suggest that as many as one in four Americans will become disabled at some point in their career, most people would be well advised to purchase an individual disability policy  as a way to supplement the one offered by their employer. Though costs and benefits for individual coverage vary considerably among businesses, occupations and states, it’s generally understood that premiums are higher for insurance over longer periods of time, and also for quick start to the payment of benefits following a claim. Premiums also tend to be higher for policies that define disability in broader terms, meaning the policy would pay benefits in a wider variety of circumstances. 

Quirks and Questions

In order for disability benefits to be received tax-free, premiums must be paid with after-tax dollars. Employer-provided coverage benefits, therefore, are considered as taxable income.  Some particularly high income earners may not be able to purchase enough disability coverage to replace their income dollar for dollar. In such cases, the insured should consider paying premiums with after-tax dollars.  In almost all cases, unless substantial cash reserves exist to narrow the gap between current earnings and covered earnings, modest to significant lifestyle changes will be required in the event of a disability.

Ask yourself these questions to begin assessing your family’s disability insurance needs:

  1. How much coverage, if any, is provided by my employer, and what are the coverage limits and maximums (for both duration and amount)?
  2. Could our family survive on our savings and/or the non-disabled spouse’s income for a time should the primary breadwinner become disabled?  If so, for how long?
  3. Will longer-term financial goals (i.e., college, retirement) be adversely impacted due to a prolonged disability and interruption in household income?
  4. Are there health concerns that may preclude me from purchasing an individual disability insurance policy?

SYM recommends for you to address in advance any risk of injury or illness interrupting your family’s income and lifestyle. Whether your strategy for managing disability risk involves insurance, additional savings, additional earnings for a spouse or some combination of the above, creating a plan well ahead of your time of need is critical, and will help you to minimize financial stress during a period of disruption and uncertainty.

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