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Make no mistake how important disability insurance is. We have written about the importance of disability insurance ad nauseam. Recall that disability insurance pays YOU a benefit in case you can’t work due to a disabling condition. That disability benefit is based on the income you have made. Sometimes, though, a disability insurance carrier will exclude the income you have made. It’s true! What if you use the wrong income amount? Or, what happens if your income increases? Additionally, what if you have several sources of income? What do you do? In this article, we discuss using the right income for disability insurance. This is an extremely important topic as your income is the basis for your monthly disability amount.
First – A Disability Insurance Refresher
As we mentioned, disability insurance pays you a monetary benefit if you are disabled and can’t work. Do you need disability insurance? Read the statement below.
“If you and your family will struggle to pay the bills and other household expenses (like your mortgage) upon your disability, you probably need disability insurance.”
If that’s a true statement, then read on.
You use the disability benefit to help pay for your:
(4) anything you need to live on
Disability insurance underwriting includes the process of insuring your income. Obviously, the carrier pays a percentage of – if not your entire – income, depending on the plan you have and your circumstances. It’s easy to see how important your income is. Depending on other factors, the carrier’s underwriting team may want to see a copy of your recent tax filing or request additional information to verify the income amount on your application.
There are really 3 situations of income for disability insurance:
(1) you are a W-2 employee with a gross salary
(2) you are a self-employed / business owner / independent contractor
(3) you have a combination of the above
That is really it. We will dive into all 3 of these situations and discuss further.
W-2 Employee Income
A W-2 situation is straightforward. Your disability benefit is based on your gross salary. You probably (and should) know this amount. If you don’t, it’s typically your wages in box 1 of your W-2.
Many disability insurance carriers will want to know your last three years of W-2 income on the application. They will want to know your year-to-date income, last year’s income, and your income from 2 years ago. The underwriters are looking for the stability of income. A typical growth or increase in income is OK. Actually, carriers expect that. However, the variability of income among years will lead the underwriting team to likely offer a conservative monthly benefit. Let’s say your W-2 income is $95,000, but it was $50,000 last year and $85,000 the year before. Not only will the carrier want to know why, but also the carrier may adjust your monthly disability benefit. However, good reasons include having a baby, taking care of a loved one, switching jobs (while in the same occupation), etc.
Traditionally, carriers will insure anywhere from 60% to 70% of your W-2 income. Remember that your W-2 income is your gross income. Or, known as your gross salary.
What does this mean? Let’s say your annual W-2 income is $50,000. If the carrier insures 60% of this, you will have $30,000 insured. On a monthly basis, this is $2,500/month ($30,000 / 12).
How Self-Employment Income Affects Disability Insurance
Disability insurance carriers treat self-employment income a bit differently. You should know what is self-employment income. If you are a 1099 independent contractor or receive income from running a business, that is self-employment.
In these cases, the carriers really need to know your net income. That is right. Your net income. What is net income? Well, for starters, it is not your gross income. Then, what is net income?
Your net income is simply your gross income – in other words, your revenues – less your business expenses. Your net income is what’s left. This is the income number disability insurance carriers want.
Don’t confuse gross income from self-employment with W-2 gross income. These are completely different.
Why do disability insurance carriers want net income? It is simple. Net income is equivalent to your W-2 gross income. How is that, you ask? Well, your net income is the amount that is taxed for federal and state tax purposes – just like your W-2 gross income. It is also the money or income that you need to live off of. In other words, the money that pays for your mortgage, utilities, food, college tuition, etc.
Too often, when I ask a business owner his or her net income, I am given gross income. Disability insurance carriers don’t want gross income – or gross revenues. You’ll find your net income on line 31 of the profit and loss statement in your tax return. (Your schedule C) Look below:
If you have other self-employment, such as a K-1 , read below.
Other Types Of Self-Employment Income
Things can get a little tricky when it comes to other types of self-employment income. What do I mean by that?
Let’s say you are a partner in a business. This is self-employment income. Your income in this case in on the K-1 statement. This is equivalent to your gross income as well. You would add any additional net income to this amount to come up with the total income for the disability insurance carrier.
Contact us if you have questions on which income you need to use. We can help.
Remember, your gross income/salary from a W-2 perspective is the same as your net income for self-employment income. Both incomes are taxed at the federal and state level. Both are incomes that you then use to pay for your mortgage, your electric bill, your groceries, etc.
If you pay yourself a salary, for instance (as some business owners do), the salary amount is added to any net income amount generated by your business.
Next, we talk about common income situations many people face nowadays.
Income And Employment Situations That Affect Your Disability Insurance Coverage
There are countless income and employment scenarios that affect your disability insurance coverage. We address the most popular here.
If you have any questions, or have a unique situation we haven’t described, as always contact us. We are happy to chat.
What About Other Employment?
It is common nowadays for people to work 2 or more jobs. Which income do you use? Well, the answer is whether or not you work in the same occupation. You see, disability insurance carriers insure not only your income, but also your occupation. If you work two or more occupations that are different from one another, the carrier selects your riskier occupation (from a disability standpoint) along with the corresponding income you make, assuming you meet the carrier’s minimum hours/week worked requirement. Most carriers require 30 hours or more for coverage. An example will make this clear.
Let’s say you are a massage therapist. You work 15 hours per week as a W-2 employee (i.e. gross income), and you supplement with a self-employed massage therapy business. Your self-employed business takes up 20 hours per week. So, all told, you work 35 hours per week as a massage therapist. You make $15,000 gross income from your W-2 job and $20,000 net income from self-employment. In this case, your income used for disability insurance is $35,000, all corresponding to your occupation as a massage therapist. Since you work 35 hours per week, you meet the carrier’s minimum hours per week requirement.
Now, same example, but let’s say as a bank teller part-time 15 hours per week instead. It is a W-2 job, and you make $15,000. You work as a massage therapist on the side 20 hours per week, making $20,000. What is your income for disability income purposes? Well, it’s not $35,000. Actually, your insurable income is $20,000 as a massage therapist. The carrier does not consider your bank teller position because you only work 15 hours per week. If the carrier accepts a minimum of a 20 hour week for coverage, then your income from massage therapy is covered.
Income From Many Occupations
We often receive phone calls from people with numerous occupations. They might earn $50,000 annually, but it’s derived from 3 or more jobs. They may work 10 hours as a barber, 15 hours as a roofer, and another 10 as a barista at Starbucks.
As you can tell, these are three different occupations: a barber, a roofer, and a retail employee (barista). In this case, since the person is working fewer than 30 hours in any occupation, disability insurance is not available. That is the hard truth. People who work in numerous occupations are usually ineligible for individual disability insurance. In this case, the person does not meet the required hours week per worked, which is usually 30. (We do work with one carrier that has a 20-hour minimum.)
In our example, the person needs to work a minimum of 30 hours in a job. For example, if the person worked 32 hours per week in the roofing position, he or she would be eligible for disability insurance. The corresponding roofing income is then insurable. The other occupations do not apply.
This situation happens more often than not nowadays, and we have other options to help. Contact us if you are in this position.
Passive Income And Disability Insurance
More and more people are growing their income passively. What does this mean? All this means is that you are not providing labor to generate your income. Maybe you are receiving interest, royalty, or commission from a prior transaction or sale. If you are not materially involved in the production of this income, the income is passive.
Carriers exclude passive income. Why? The income generates whether you are disabled or not. Many carriers have a 10% rule when it comes to passive income. In other words, if passive income accounts 10% or more of your total income, disability insurance carriers will make an adjustment to your available benefits. If you think you can hide any passive income, think again. Upon application or upon disability claim, the carrier can request copies of your tax returns to confirm sources of income. They can do this as they are potentially insuring you and paying a claim. They have this right.
You live under a rock if you don’t know the internet provides many passive income opportunities. In some cases, these situations aren’t really passive income. If you are an internet marketer, for instance, that is an occupation. However, if you work from home and dabble in arbitrage strategies, with no official company or legal status, likely a carrier will challenge your occupation and income. In my opinion, this is a gray area. Even so, if you don’t meet the carrier’s minimum work requirement (usually 30 hours/week), many of these internet side-hustles are eligible for disability insurance anyway.
What If Your Income Increases?
We all want increasing income. How can you effectively protect the income increase with disability insurance? Well, at the time of application, you must select a “guaranteed purchase option”. This option allows you to purchase more disability insurance without any health evidence when your income increases. Carriers usually specify the timeframe or window when you can purchase more disability insurance. You must provide financial evidence, however, which is commonly supported with your tax return. Keep in mind, though, that this income increase corresponds to your insurable occupation.
Let’s say again you are a roofer making $50,000. You have disability insurance as a roofer with a guaranteed purchase option. You dabble in internet arbitrage and suddenly made $75,000 alone from these arbitrage strategies. Can you insure the $75,000? Likely not through the guaranteed purchase option since your insurable occupation is a roofer.
Please note that not all states allow guaranteed purchase options and some carriers have limitations.
We hope this article informed you of the importance of selecting the right income for disability insurance. It’s important that you have the right income amount for disability income purposes. For most people, your income will either be your W-2 employment income or your net income from self-employment. People who work in the same occupation, but have both W-2 and net income simply add both together.
If you have multiple occupations and income streams, disability insurance carriers will have a hard time determining your insurable income. You may even be uninsurable simply from working in numerous occupations.
Regardless of your situation, we can likely help or point you in the right direction! (That is always good, right?) Contact us or use the form below. We would be happy to discuss with you your situation and see how we can help. As with anything we do with our clients, we always have your best interest. This means if we can’t provide the right solution to meet YOUR needs, we will recommend the one that will.