Do you think you could ever get hurt long enough that you couldn’t work?
Most people don’t think that. However, 1 in 3 working adults will experience a disabling event lasting longer than 90 days. Are you prepared? What if you could not work for 6 months? Or a year? Or longer? How would the bills be paid? What would you do?
This is where disability income insurance comes into play. It insures your ability to earn an income – i.e. your paycheck. Using that spare tire analogy, think of it as a spare tire to get you and your family back on the road financially if you were to get hurt. It is a much needed type of insurance for any working person.
“Wait,” you say, “I have disability insurance through work. I’m all set.”
There are unforeseen problem with having disability insurance through your employer’s benefit program. Please read on.
The Problems With Disability Insurance Through Work
Most of you probably have some type of disability income insurance through work. That is great! We found when working with clients there are several issues that could potentially harm them if they had to file a claim:
- Most did not know the ins-and-outs of their disability insurance policy. For instance, one client assumed if she went on disability, her policy would pay out for the rest of her working career. Unfortunately, her policy allowed benefits for 1 year.
- Most did not understand their policy definition of disability (it can be different!).
- Most did not realize that if they left their employer, they could not take their insurance with them.
- Most did not realize their disability benefit was taxable.
That is right. In regards to #4 above, most likely, you are paying your disability income insurance with pre-tax dollars. Uncle Sam has to get his money some way, so he taxes you on the benefit payments – payments you dearly and probably need to keep your family financially “going.”
Here is a quick illustration. Most of you probably understand that you are limited to 60% of your gross salary when you file a disability claim. There are a couple of good reasons insurance companies do this, and the main reason is to prevent people taking disability and then not urging them back to work. If I could receive 100% of my gross salary while on disability, I may not want to go back to work, either.
Let’s say your monthly gross salary is $5,000 per month. That means, at a 60% cap, you will receive $3,000. Ok, not bad. You can make that work. But, let’s say your tax rate is 20%. That will essentially drop your disability income to about $2,000 per month, give or take. Wow, a lot tighter. Maybe you can make budget adjustments or your spouse can adjust his or her own work withholdings – or work more – but there is a squeeze. What do you eliminate? Food on the table? Children activities? You will probably have an increase in medical costs due to the disability. Those costs won’t go away. What do you do?
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A Better Option
With an individual disability income policy, that tax issue isn’t the case. Because you aren’t paying the premiums using pre-tax dollars, the benefits are tax free. It can, in effect, lower your family’s overall tax rate since it is not included in income. (We are not tax advisers. Seek a tax adviser to discuss your specific situation.) An individual policy will also conform to your needs and goals, whereas a group policy at work tends to be plain vanilla and may not fit your situation (see #1 in the example above).
Some Basics on an Individual Disability Income Insurance Policy
While we can’t go into detail here on the ins-and-outs on disability insurance (trust us, you will scroll forever reading about it!), we do discuss at length common and head-scratching topics about disability insurance in our education blog. Feel free to check out more disability insurance discussion there.
We will give you an overview on what insurance carriers look for when someone applies for disability income insurance:
- Your occupation – that is right, your occupation plays a part in the risk classification. A mechanic would be charged a higher rate compared to an office manager, all things being equal.
- Your health – the probability of disability is higher than premature death. Underwriting adjusts for this fact.
- Your elimination period – think of this as a deductible. Once the elimination period ends, you will start to receive disability income benefits. Elimination periods can run from 30 days to even 365 days or 730! The longer the elimination period, the lower the premium, all things being equal.
- Your benefit period – you can receive benefits for 6 months or up to your retirement age (most insurance companies accept age 65 or 67). The shorter the benefit period, the lower the premium.
- Then, there are many riders that can be added – some riders will pay extra if you can’t perform 2 out of the six activities of daily living. Some will allow you to purchase more disability insurance guaranteed, no health questions asked. Others will allow you to change the definition of disability to a more favorable definition.
Which brings us to our last point. The definition of disability can be the deciding factor if you will receive payments. You might say to yourself, “I have social security to fall back on if I get hurt.” That is not necessarily the case. Between 35% and 40% of applicants are denied disability income from social security. The reason: social security uses a strict definition of disability in which many people do not qualify.