Disability insurance: What it is and why you need it
One of the most important assets you have is the ability to work and earn an income. But what happens if you lose your ability to work – even temporarily? The possibility is by no means remote. In fact, the Social Security Administration estimates one in four 20-year-olds will experience a disability during their working years.1
Disability insurance – also known as disability income insurance – can give you income to live on if you become temporarily or permanently disabled.
Is disability insurance worth it?
Do you need disability insurance? If you depend on a paycheck to cover your living expenses, the simple answer is yes. This article will provide answers to three other questions people commonly have about disability insurance:
The different kinds of disability insurance policies – and what they’re for
All disability insurance policies are designed to help you avoid financial hardship by giving you money if you become disabled. But not all types of disability are the same. There are different types of policies you can get:
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Short-term disability insurance
Also called STD, this policy is for temporary disabilities. It is designed to replace 60-80 percent of your income for a short period: typically 3-6 months (and rarely more than a year), or until you get back to work.
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Long-term disability insurance
Also called LTD, this type of policy is designed to last for many years – through retirement (age 65, 67, or Social Security’s normal retirement age) if needed. If something happens and you can no longer work, it replaces 50-67 percent of your income (for an individual policy) or about 40-60 percent (for group long-term disability).
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Social Security Disability Insurance
Also called SSDI, this coverage comes as part of your Social Security benefits. However, it is usually much more challenging to qualify for than a disability policy purchased individually or through work. SSDI applicants have a higher chance of rejection2 – and the monthly benefit is typically lower than with a private long-term disability insurance policy. That’s why specialists say you shouldn't rely on Social Security Disability Insurance as your only source of income protection.
How disability insurance works, and what to look for in a policy
The basic concept of disability insurance is simple: If you become sick or injured and can’t work due to a disability covered by your policy, you receive benefits. But that simple statement describes an enormous range of real-life possibilities, so there are important issues that will need to be clarified before you can get a disability policy. That’s why you need to have an agreement – a mutually-binding contract – with an insurance company that answers the following questions about exactly how your disability insurance benefits will work:
1. What is the policy’s definition of disability?
Some types of catastrophic injury or illness make you clearly unfit for work, but others may not be so obvious. There needs to be a clear understanding of what it means to be disabled to qualify for benefits under your policy. There are several different definitions of disability and will vary by carrier. It may also spell out different specific levels of disability, such as a “partial disability,” along with the percentage of the total disability benefit you can receive under that definition.
There’s also another vital issue that needs to be clarified in the definition of disability:
Own-occupation or any-occupation?
A long-term disability policy will include this distinction in its definition of disability, and the implications are significant. With an own-occupation policy, you need only be disabled from doing your current work or profession in order to qualify for benefits. For example, a surgeon who can no longer use their hands to perform surgery would most likely qualify for benefits, even if that surgeon was otherwise healthy enough to do other work.
With an any-occupation policy, you only qualify for benefits if you can’t do any work. If you’re still able to work at some job – even in a much simpler, lower-paying position – you would not qualify for the full benefit amount, and you may not be eligible for any benefit. That’s why this type of policy is almost always less expensive.
If you have a long-term disability policy through work, it will likely be split into an own-occupation portion (which typically lasts for 24 months), followed by an any-occupation portion. In this case, you may still qualify for disability benefits while working at either another job, or a modified version of your original occupation, while earning up to a certain percentage of your pre-disability salary.
Note that in a short-term disability policy, this usually doesn’t apply because the assumption is you will only be out of work a short time before returning to your present occupation. However, most policies do allow partial work while benefit payments are being made.
2. What’s the policy’s waiting period?
Every policy has a waiting or “elimination” period. This is the period of time you have to wait after you are disabled until benefits begin and the insurance company starts replacing your income. It will generally be shorter for an STD policy and longer for an LTD policy. It can also be longer or shorter depending on the specific carrier and policy: a longer elimination period tends to lower your premiums somewhat, and a shorter period tends to raise them.
3. What is the benefit amount?
This is the amount of money that will be paid to you, usually monthly, once the elimination period has been met – clearly one of the most important aspects of a disability policy. Most financial professionals suggest you should look to replace about 60-80 percent of your after-tax income.
4. What is the benefit period?
This is the maximum length of time that you can receive benefits. In a short-term policy, this will typically be between 3-6 months and rarely more than a year. For a long-term policy, there’s a much wider range of possibilities. The benefit period could be as little as two years (as is the case with one of Guardian’s group policy options), or it could go to age 65, 67 or Social Security’s average retirement age (unless you recover from your disability).
5. What are the features and options of the policy?
Remember: a disability policy is a contract, and like many contracts, it contains fixed terms and provisions, but there are also optional provisions, which are called riders. Make sure to go through all the provisions to understand the conditions of your contract and the circumstances under which you will receive a benefit.
For example, there will likely be one or more provisions that say if you’re allowed to do any work – even part-time – while still qualifying for some benefits. One of the most popular optional provisions is a cost-of-living adjustment (or COLA) rider3 that states the insurance company will increase your benefit to account for inflation and/or cost of living increases.
6. How much will you pay for disability coverage?
Expect to pay between 1 to 3 percent of your annual income for disability insurance as an individual.4 If you receive disability coverage through work, the rate will vary. The actual premiums you pay for a policy will depend on the following factors:
| Age | The older you are, the higher your premiums |
| Health | The fewer medical issues, the lower your premiums. You should expect to have a medical exam when getting an LTD policy. |
| Smoking and risky activities | Smoking will raise the cost of your policy, as will other risky activities such as scuba diving and auto racing |
| Occupation | If you have a high-risk occupation, or work in a dangerous environment (e.g., an oil rig), your premiums will be higher |
| Definition of disability | The broader the definition of disability, the higher the premium; own-occupation coverage will cost more than any-occupation coverage |
| Waiting period | A shorter waiting for benefits will increase policy cost |
| Benefit length | The longer the insurer has to pay benefits, the higher the policy cost |
| Income | The more income you need to replace, the higher the cost |
| Optional features | Many riders – such as the cost-of-living adjustment rider that increases your benefit for inflation – will also increase your policy cost |
How to get a disability policy
Other than SSDI, which is paid for as part of your Social Security premiums, 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 benefits package. And 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: The premium is typically lower than for an individual policy because the company or association is buying for a large group of people. In addition, your HR department (or the association’s management) will likely have more expertise and leverage than an individual would to negotiate favorable terms. They will also act on your behalf to ensure the insurance company's financial stability (more on that below).
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 (which is common), then any benefit you receive down the road will typically be taxed. If an employer pays for the coverage, the benefits will be taxable. Finally, if you leave the company or association, you'll also lose your coverage in most cases.
Individual disability insurance
This is a policy you purchase for yourself, so you can tailor it to your needs. As it is paid for with after-tax dollars, the replacement income it provides is also tax-free. It’s typically bought through a financial representative; if you don’t have one, or if that person doesn’t have a lot of experience with disability insurance, a Guardian financial representative can give you a disability insurance quote.
Have a group disability policy? Consider adding a supplemental policy.
This approach lets you take advantage of a low-cost group policy for a portion of your needs, then individualize your protection with a secondary policy. Here are a few of the many scenarios where that can make a lot of sense:
- Your group only offers STD: Take advantage of this to get coverage for the most common types of disability situations; then purchase an individual LTD policy tailored to your long-term needs.
- The group disability benefit is capped: If the benefit is capped (or limited) to, say, $5,000 a month – and then taxed at a 25% rate – you’ll net $3,750. That may not be enough to live on comfortably.
- The LTD benefit period doesn’t last to retirement: If your group LTD plan only has a 5 or 10-year benefit period, and you’re 20 years from retirement, that could be a problem. Talk to your financial representative about a policy that can fill the gap.
As we’ve said, disability insurance is one of the most individualized types of insurance you can get because every person’s situation is unique.
Finally, check the financial stability of your insurer before you sign
You want to be sure the insurance company will be around to pay a benefit if you need it – which could be years or even decades down the road. Fortunately, it’s easy to look up that information. There are reliable independent sources for financial strength ratings (FSRs) which you can find online, including A.M. Best, Fitch Ratings, Moody’s, and Standard and Poor's. As an example of the kinds of ratings to look for, here are Guardian’s FSRs:
Frequently asked questions about disability insurance
What is a good reason to have disability insurance?
Disability insurance protects and replaces a portion of your lost income if you can't work due to a qualifying illness or injury. If, as the primary income earner, you have a life insurance policy to replace the income your family needs if you die, shouldn't you also have coverage to replace lost income and cover living expenses if you're disabled? That's precisely what disability insurance covers – and the risk of disability for a working-age person is much higher than the risk of death. It's also important to know that workers' compensation only pays a monthly benefit (and sometimes, medical bills) for medical issues caused at work. It's not a substitute for disability insurance.
Is long-term disability worth the money?
Many people think that disability is primarily caused by caused by rare, catastrophic events – like a severe car accident. However, most long-term disability claims are caused by illness and medical issues.5 How would you replace your monthly income in the event of a permanent disability? Even a robust emergency fund isn't likely to be enough to support your family long-term.
Is disability a lifetime insurance?
Different kinds of disability insurance plans provide benefits for various lengths of time but don't typically provide income for life. Short-term disability policies last a year at most; long-term disability insurance can provide benefits for a set number of years (i.e., 2, 5, or 10 years) or until reaching retirement age, even if it's decades away.
