Disability insurance is a very important part of financial planning and is an often neglected area of significant financial importance. Because there are not many professionals that specialize in this area and it can be difficult for people to understand how important this insurance need is, it often goes uninsured or significantly under-insured, which can be a catastrophe for the unlucky individual.
While we do not sell insurance, because we are a “Fee Only” firm, we do help our full-service clients to determine the appropriate amount of insurance and where they should purchase their protection. Firms that we refer to (that sell loaded products) must donate 25-50% of the commission due to a charity of our choice.
Why Disability Insurance (DI) is important:
Did you know that you are 3-5 times more likely to become disabled than to die? And you’re still here!!! Unable to make a living and support yourself. Catastrophic health insurance and Long-Term Disability Insurance (LTDI) are most individuals most important insurances.
Who needs Disability Insurance?
The easy answer is that anyone that could not retire comfortably today needs disability insurance. The amount and type depends on your specific circumstances and goals, but if you couldn’t retire today and live the life that you wanted than you should seriously ensure that your disability protection is adequate.
Who else can benefit from Disability Insurance?
Beyond individuals that “need” DI, there are also a long list of people/entities that could benefit from additional DI as well:
- Workers in high risk professions – Those that have a higher risk of being disabled should acquire as much coverage as they should. This can be difficult because the insurers understand their risk as well and are very adept at limiting coverage to these groups. If you are at increased risk (such as a police officer, firefighter, construction worker, etc.) you should keep your eye peeled for good employer/group/association LTDI policies that may be available to you.
- Highly compensated employees – Most employer policies max out at $5-10k per month so the higher your income the more likely that your employer policy is inadequate.
- Self-employed individuals – Most self-employed individuals do not have LTDI because they don’t have an employer to offer it to them and they never bought a policy themselves. This is a big mistake and should be rectified asap.
- Small business owners – In additional to the small policy they may provide to employees, business owners need to protect more of their income, and probably need to purchase overhead expense protection if their business could not function without them. Otherwise the business could fail without their integral leadership and skills, which would destroy and import income source as well as a potentially large asset.
How does Disability Insurance work?
Let’s bread this down piecemeal:
- Definition of Disability – One of the most important part of disability insurance is how they define disability. Do they define it as totally disabled or partilally disabled. Do you have to be able to not work in ANY job or only your own occupation.
- This is especially important for highly skilled professions with high incomes.
- Primary Benefit – The amount they will pay you per month once the definition of disability is fulfilled.
- Social Security Offset – This is the part of your ebenfit which will be reduced if you receive disability benefits from Social Security, a State Pension, or other public source.
- Catastrophic Benefit – If you are disabled catastrophically (generally loss of sigh, hearing, speach, more than two limbs, or become mentally impaired) then this is the additional benefit they will pay you. This is a rider in many policies and may not apply to your particular policy.
- Residual Benefit – If you are partially disabled then this benefit will pay you the % of your benefit of which your income is reduced due to disability (i.e. if your income is reduced 60% then you get 60% of your primary benefit). This is a rider in most policies and may not apply to your particular policy.
- Benefit Period – How long will benefits pay once triggered and as long as you meet the definition of disability. Could be: 2-10yrs or to to age 65-70 depending on the policy purchased.
- Elimination Period – The amount of time that must elapse from meeting the definition of disability until benefits start to pay (some people refer to this as their deductible). This is usually 90 days, but could be anywhere between 30-180days.
- Cost of Living Adjustment (COLA) – Once benefits are triggered this rider increases the policy benefits each year to attempt to offset inflation. This is usually 2-6%/yr depending on the options selected in the policy. This is a rider in many policies and may not apply to your particular policy.
- Guaranteed Purchase Option – Especially important for people that buy their policies early in their career, this rider allows the policy hold to purchase additional coverage without the insurer getting to reevaluate their health. They must pay for the additional coverage but if the policy holder’s income increases but their health has deteriorated this can be a very valuable feature.
- You must be diligent with this feature because most insurance companies have strict rules on this and if you fail to abide by them then they take them away.
- Renewability – There are generally two types of policies:
- Guaranteed Renewable – This policy is cannot be terminated by the insurer as long as the insured pays premiums but the premium can increase if the State Insurance Commissioner approves such an increase.
- Non-Cancelable – This policy’s premium is guaranteed and cannot be changed in addition to the fact that the policy cannot be terminated as long as the insured pays premiums.
- Rehabilitation Benefit – An additional benefit the insurer provides to help the insured rehabilitate because it is in their best interest to help you get back to work.
Types of Disability Insurance:
There are lots of different insurers and policies but the most important differentiator are the types listed below:
- Employer Long-Term DI – A policy provided by the employer (many times as a rider on their health insurance plan) that provides a basic LTDI benefit. These are usually Social Offset policies which reduce their benefit for anything received from SS or State Pension and have maximums of ~$5,000/mo.
- Most of the time these are employer paid which means the benefit to you is taxable. Generally, if your employer give you the option to pay the tax on this, you will want to so the benefits would be tax free if you ever needed them.
- If you make more than ~$80k then you should consider buying a supplemental policy.
- Employer Short-Term DI – This coverage tend to be elective and short-term. They usually kick in after 30 days and pay to day 90, when the LTDI would kick in. For employees with good emergency savings and/or significant sick & vacation time built up, this may be an unnecessary expense.
- Employer Long-Term Supplemental DI – Some employer s may offer this benefit, which provides additional benefits (at the employees’ expense) to purchase extra coverage. You really have to read the terms and costs to see if this or an individual policy would serve you better.
- Association Long-Term DI – These can be excellent deals for professionals such as doctors, dentist, optometrists, etc. because they are basically good individual policies with 10-30% discounts because of the large group discount. However, you still have to read all the benefits to make sure it’s a good deal and not just stripped of benefits to reduce costs.
- Individual Long-Term DI – These are generally the best policies because you can build them however you like. You can build the best definition of disability, cut out benefits you don’t want/need, but they are also a bit more expensive as well.
How we help our Clients:
Evaluate the Need: Through our financial planning process we will help you to identify your need or opportunity (at the Gold client level or through the purchase of a financial plan).
Recommend the Amount and Type: Through our analysis above we will help you determine how much DI you should purchase and what your options are for attaining coverage.
Help to shop with client(s): Through our experience and industry contacts we will help you to identify which carrier will serve you best. Remember we are the probably going to be the only person that is a fiduciary to you throughout this process so this is a very important/valuable service that we provide.