Most people know living without health insurance is very risky (and shouldn’t be done). But people are much less aware of the importance of long term disability insurance. The census bureau estimates that you have a 20% chance you will be disabled in your lifetime. A disability can decrease your earning power and also can increase your expenses (to cope with your disability). In my opinion your emergency fund is best used for short term disability insurance.
One of the most important things you can do is be sure you have disability coverage. In the USA about 50% of the jobs provide coverage. If your job does not you should get insurance yourself. Many companies may not pay for disability insurance but may allow you to pay for it (this often can be the best option as the company can gain a better price than individuals but you have to check out the details). Also social security includes some disability insurance coverage but it is very limited. Relying on social security alone is not wise. For one thing it does not protect you from being unable to do your current job but will only pay benefits if you are unfit to do any job.
There are numerous factors to consider for disability insurance. Normally a long term disability insurance policy will pay 50-60% of your salary (be sure to check and see, and check if there is any cap). The terms of the policy will also determine how long you will be paid, being paid until at least 65 is what I would suggest – but some only pay for a limited number of years.
Often policies will offer pro-rated benefits if you earning power is reduced by a disability but you are still able to earn something. So you may have a policy that pay 60% of your original salary but if you make 50% of your previous salary then the payout is reduce to say 20%. So if you originally made $80,000 and now, due to a disability (not just losing your job), you could no longer do your job but could do one that paid less – say $40,000. You would then get your new salary of $40,000 + $16,000 in disability payments or $56,000.
Another detail you should check is whether the payments you will receive are indexed to inflation. In addition, make sure the policy is guaranteed renewable. You also want to buy from a reputable insurance company (check AM Best, Moody’s, Weiss rating agencies). It doesn’t help to have a guaranteed renewable policy if the insurance company goes out of business.
Another thing to consider is buying additional disability coverage. For example, if your company provides a 60% coverage policy it is often possible to purchase addition coverage (to provide additional benefits of 10% or 20% or more of your current salary).
A rough guide is disability insurance will cost 1-2% of the income replaced. For example, a policy replacing $50,000 per year of annual salary would cost about $1,000 per year. Of course, the older or sicker you are the higher the cost. Premiums are based on risk factors, so if you have health risks that will cost more. And, as age is a significant disability factor, the older you are the higher the cost will be.
Remember if you have disability insurance through work, and lose you job you need to get your own disability insurance. This is yet another reason to have an adequate emergency fund.
Related: Personal Finance Basics: Long-term Care Insurance – Personal Finance Basics: Health Insurance – How to Protect Your Financial Health – Life Happens: disability insurance
Comments
8 Comments so far
I’m pretty sure long term disability isn’t taxed either, which should make the 60 or 70 percent pretty comparable to your 100% salary that is taxed. I’m trying to think back to my personal finance class in college, so I could be wrong about this.
I believe if you paid your premiums with after tax dollars then it is not taxed. I am not sure, but I have read that. I am not sure how you pay premiums with pre-tax dollars but maybe that can be done through your employer.
One thing to remember is you don’t pay social security tax on the benefits and I wouldn’t think medicare taxes either. Again, I am not sure but that is my understanding.
Thanks for the food for thought. This will be the next project for my spouse and me to work on. Within the year, my husband and I did all the leg work on our life insurance policy and got an amount that exceeded what we were initially offered on account of the medical issues of one of our children.
Income from disability insurance provided from your employer is fully taxable as income because your company paid the premiums and those premiums were tax deductible. Earning $100k with 60% DI will get you $60k. After tax, you will net ~$45k (assumed 25% tax bracket). It’s a good idea to purchase private insurance, paying you own premiums can potentially net you ~$70k after tax.
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Studies show that a 20 year old has a 30% chance of becoming disabled before reaching retirement age…
Is the 50% or 60% of your salary that DI would pay be 50/60% of one’s GROSS salary or one’s take home salary (take-home being equal to gross minus applicable taxes)?
Disability insurance payments should be of your gross pay (not net pay) – you should always check the policy to understand exactly what the rules are for that policy).