How does a disability insurance policy work?
One in four workers will become disabled during their working years. One out of every eight will experience a long-term disability that lasts more than five years.1 Disability is a risk that every working person has to face, regardless of their occupation. And when people can’t work due to illness or injury, their income is also at risk.
Disability insurance is one of the most effective ways to protect a portion of your income – and maintain your way of life. This article will help you better understand:
- Why you need disability insurance
- How disability insurance policies work
- What disability insurance costs and how to get it
- Frequently asked questions about how disability insurance works
Why do you need disability insurance?
A lot of people associate disability insurance with accidents. But disability insurance isn’t just for accidents: the vast majority – almost 90% – of all long-term disabilities are caused by illnesses such as cancer, heart disease, lupus, arthritis, and multiple sclerosis.2 Even if you always practice safe and healthy habits, there’s no guaranteed way to protect you from any of these maladies. But there is a way to protect your family’s way of life if you lose your ability to earn an income.
Disability insurance – also called disability income insurance – replaces a portion of your income when you’re too sick or injured to work. The benefits you receive can be used for anything you want or need, including:
- Credit card payments
- Auto loans
- Personal loans
- Retirement contributions
- Student loans
- College or childcare
- Groceries or dining out
Two types of disability policies: short term and long term
Short term disability insurance (or STD) is for temporary disabilities and is designed to replace up to 60%-80% of your income for a short period of time. STD is often provided through your workplace, either as a mandatory or voluntary benefit. The typical benefit period is 3-6 months (and almost never more than a year), or until you can get back to work.
Long-term disability insurance (or LTD) is for more severe and even permanent disabilities. It’s sometimes offered as a workplace benefit, but is often purchased as an individual policy. The benefit is designed to last for many years – through retirement if needed – replacing up to 60%-80% of your income if something were to happen and you could no longer work.
How do disability insurance policies work?
A disability policy is a binding contract with an insurance company to pay a specific monthly benefit while you are disabled. Every policy – whether long term or short term – has five basic features:
- Premium: The amount you (or your employer) pay for the policy. Premium amounts vary based on the length and type of coverage, your health, the benefit amount, and other factors.
- Benefit: The amount you receive each month when you can’t work. It should be between 60 to 80 percent of your monthly salary. The benefit of an individual policy usually isn’t taxed (unless paid for with pre-tax dollars); for a group plan if paid in part by your employer, the benefit will be taxable.
- Benefit period: The length of time you can receive benefits. For STD this will typically not be more than a year; for LTD it could range from two years to retirement, or until you recover from your disability.
- Waiting period: Also called an elimination period, it’s the amount of time after you are disabled until you can start receiving benefits. It will generally be shorter for STD and longer for LTD.
- Definition of disability: Every disability policy has a specific definition of what it means to be disabled in order to qualify for benefits. An own-occupation definition means you qualify if due to disability you can’t work in your occupation, including any specialty; any-occupation means you only qualify if disability prevents you from working in any occupation for which you are or become reasonably suited by your education, training, or experience. Different levels of disability may also be defined, (for example, “partial disability”) which can qualify you for various percentages of your total benefit amount.
The details matter. Ask detailed questions about the policy.
The above features vary from policy to policy, so make sure to ask specific questions that’ll help you understand what benefit you will get, when you will get it, and under which circumstances. For a group STD policy, you may not have many options – you more or less have to take what’s offered. But if you’re purchasing an individual LTD policy, it can be a highly personalized contract with riders (or optional provisions) that tailor the coverage to your specific needs. These questions can help you evaluate the quality of a disability income insurance policy — and how well it will support you when you need it most.
How much coverage can I qualify for?
Make sure the monthly benefit amount will be enough for your needs. You typically can’t qualify for more than 80 percent of your salary, but since the benefit of an individual policy isn’t usually taxed that may be more than enough. However, some group policies will cover only 40-60 percent of your salary – and it’s often taxable. In that case, you may want to consider getting a supplemental disability policy through your employer or an individual policy.
How long will benefits be payable, and when do they begin?
Make sure that you understand the policy’s waiting period – how long it takes to qualify for benefit payments – and the benefit period, which is critical to meeting your income needs over time. Standard benefit periods for an LTD policy include 2, 5, or 10 years; to age 65 and to age 67. A few companies, including Guardian, offer coverage to age 70.
Could my policy be changed or cancelled — or could my premium increase?
Policies that are both non-cancellable and guaranteed renewable offer the strongest premium and coverage guarantees available, which means if your premiums are paid on time, your policy cannot be cancelled, premiums cannot be increased, and policy provisions cannot be changed. Policies that are only guaranteed renewable cannot be cancelled, but premiums can be increased.
Will my benefits keep pace with inflation?
Most LTD policies offer a rider (or optional provision) to help your benefits keep pace with inflation. A Cost of Living Adjustment (COLA) rider will adjust benefits each year while you remain disabled and eligible for benefits. COLA riders can be vital to maintaining your standard of living during an extended disability.*
What other types of riders offer added protection?**
Many other riders are typically available, and some of the most popular choices include:
- Basic or enhanced partial disability benefit rider: These options protect you by paying a partial benefit if you suffer an injury or illness that limits your ability to work but doesn’t cause total disability.
- Student loan protection rider: This optional benefit provides extra money to make student loan payments during a specified period. It is particularly useful for early-career professionals such as doctors and lawyers who have invested heavily in their education.
Future purchase option: This lets you increase coverage in the future as your income rises, without having to undergo a medical exam or provide proof of insurability.***
What will determine if I’m considered disabled?
The definition of total disability is the core of any disability policy because it is the key to determining your eligibility for benefits. The definition outlines what constitutes being totally disabled, but it does not always mean the same thing in every carrier’s policy. Different carriers also define own-occupation disability differently. Take the time to make sure you understand this aspect of your policy.
To illustrate, here’s how own-occupation coverage works in our individual policies:
- True own-occupation disability insurance
Provides you with the ability to receive your full disability benefits while totally disabled, even if you’re gainfully employed in another occupation or capacity — with no reduction in benefits.
If you want to pursue another occupation while totally disabled in your occupation, our True Own-Occupation definition does not prevent you from doing so. For example: A surgeon suffers a back injury and becomes totally disabled and she’s unable to continue practicing medicine. While on claim, she begins teaching medicine at a local university, while still collecting benefits.
- Two-Year True Own-Occupation
This definition of disability offers a two-year period of True Own-Occupation. If you’re still disabled after two years, your coverage converts to a Modified Own-Occupation definition of disability for the remainder of your benefit period. Modified Own-Occupation refers to when, solely because of sickness or injury, you’re unable to perform the duties of your own occupation, and you’re not gainfully employed.
- Two-Year Modified Own-Occupation
Another option is to simply have a Modified Own-Occupation definition for the first two years. If you’re still disabled after two years, your coverage converts to an Any-Occupation definition, which refers to when, solely due to sickness or injury, you’re unable to work in any occupation for which you are or become reasonably suited by your education, training, or experience..
What does disability insurance cost, and how do you get it?
The cost of a disability policy – especially an individual policy – can vary greatly based on benefit length and amount, age, gender, occupation, and riders. One rule of thumb: expect to pay between 1 to 3 percent of your annual salary. There are two basic ways to get a disability insurance policy:
Group disability insurance through your work or an association.
Your company may offer STD or LTD insurance as part of your employee benefit package. If you’re self-employed you may be able to get disability insurance through a professional association. Either way, group disability insurance can be an excellent choice: Because the company or association is buying for a large group of people, the premium is typically lower than for an individual policy. In addition, your HR department (or the association’s management) will likely have more expertise and leverage to negotiate favorable terms.
An added benefit to getting a policy through your employer is that they may also subsidize a portion of the premiums, further lowering your cost. On the other hand, because the company or association is effectively “buying in bulk,” you will probably have less opportunity to tailor the policy to your needs. If the premiums are paid with pre-tax dollars (usually the case with employee benefits) then the income benefit you get down the road will typically be taxed. Finally, if you leave the company or association, in most cases you’ll also lose your coverage.
Individual disability insurance
This is typically an LTD policy you purchase for yourself, so you can tailor it to your needs. As it’s usually paid for with after-tax dollars, the replacement income it provides is also tax-free. It’s most often bought through a financial professional; if you don’t have one, or if that person doesn’t have much experience with disability insurance, a Guardian financial professional; can give you a disability insurance quote.
Frequently asked questions about how disability insurance works
Don’t I have disability coverage through Social Security?
Social Security Disability Insurance (or SSDI), is a part of your Social Security benefits. However, it is usually much harder to qualify for than a disability policy purchased individually or through work. Most SSDI applicants are rejected – and the benefits are typically lower than with a private disability policy.3 That’s why most experts say you shouldn’t rely on SSDI alone for income protection.
My company offers LTD with up to 60 percent income replacement, but it’s not enough for my family. What can I do?
Consider getting supplemental individual disability insurance through your employer, if it’s offered to you. It’s a policy that provides extra coverage to bridge the gap between what you’ll receive from your current LTD policy, if you could not work due to injury or illness. You may also purchase an individual policy through a financial professional.
I’m an employer, and my company isn’t required to offer disability insurance. Should we?
Compensation is obviously important to anyone who works, so disability insurance is a desirable benefit that can help attract and retain employees. If you are worried about the extra cost, you can offer STD or LTD as a voluntary benefit and can be set-up to be paid for by your employees, but they receive attractive group rates.