Disability insurance for the self-employed: What you need to know

Disability insurance – also called disability income insurance – is coverage you may need to help protect yourself in the event of a serious illness or injury. Disability isn’t just a theoretical possibility: One in four working adults will become disabled during their working years.¹

As a sole proprietor, this coverage is doubly important: it helps protect the income of your most essential employee – i.e., you – and keeps your business going.

This article will help you understand how to get the protection you need by explaining:

• How disability insurance works for you and your business
• How much protection you need
• What a policy typically costs and how to get it
• Frequently asked questions

Generally speaking, there are two types of disability insurance for people who work. Short term disability insurance (STD) provides temporary income protection for employees, typically for up to six months of disability. Long term-disability insurance (LTD) provides protection that lasts for years – and even through retirement – depending on the terms of the specific policy. 

However, disability insurance for people who own their own business works a little differently – and the process of getting coverage can be more involved:

• Many insurance companies require proof that you’ve been self-employed for two years and will likely ask to see tax returns.
• STD, which is typically bought as group coverage by an employer for its workers, is difficult and expensive to obtain as an individual. 
• It may not be enough to get protection for the income you draw; you should also get coverage for business expenses – like rent, utilities, employee salaries.

As a business owner, there are several types of coverage you should consider:

1. Individual disability income insurance – an insurance policy that protects your personal income if you’re unable to work due to injury or illness. Your policy is an individual contract with an insurance company that defines the following: 

• Premium: The amount you pay for coverage.
• Benefit: The amount you get each month if you are unable to work. It should be between 60% to 80% of your monthly salary and typically isn’t taxed – unless paid for with pre-tax dollars.
• Benefit period: The length of time you receive a benefit, which can range from two years to retirement, or until you recover.
• Waiting period: Also called an elimination period, it’s the amount of time after you are disabled until you can start receiving benefits. 
• Definition of disability: Your policy’s specific definition of what it means to be disabled in order to qualify for benefits. An own-occupation definition means you qualify if you can’t work in your specialty or field; any-occupation means you only qualify if you can’t do any work at all.
  
  It also makes sense to get a residual or partial benefit rider: With this option, if you are able to do some work, you can receive a portion of your monthly benefit as you recover and work to rebuild your business. 

2. Business overhead expense disability insurance – If you become disabled, your business’ income will drop – even as business expenses go on, including rent, utilities, taxes, and employee salaries. Major carriers such as Guardian offer overhead expense coverage that can reimburse up to 100% of covered expenses to ease your cash flow worries. 

Guardian also offers more specialized protection that provides business loan coverage. This feature protects your ability to pay business loans and other contractual financial obligations, such as business purchase or start-up loans, equipment purchases or lease agreements, and business expansion loans. This coverage can fund up to 100% of regular payments and allows you to tailor the length of the policy to the duration of your loan or loans, so you only pay for the coverage required.

To answer that question, start by estimating your current monthly living expenses, including:

• Housing
• Utilities
• Food
• Childcare
• Loan payments
• College savings or tuition
• Retirement savings
• Auto expenses
• Any other regular expenses

Next, assess your monthly business expenses:

• Rent or mortgage
• Utilities
• Insurance
• Salaries, benefits, and other compensation
• Taxes
• Loan payments
• Miscellaneous

While you can usually only get coverage to replace up to 80% of your personal income, it’s possible to get coverage for up to 100% of your fixed monthly business expenses. If you have substantial savings or other liquid assets, you can take those into account and adjust your needs accordingly. You may also decide later in the process that certain expenses may not be necessary; however, you need to have a solid estimate of your personal and business expenses as you start shopping for a policy. 

Your lifestyle and needs are uniquely your own – and your business is a unique entity with its own customer base, processes, assets, and liabilities. Your policy needs to be tailored with a specific benefit amount and length that reflects those requirements, along with other provisions that address additional concerns, for example, by getting a Cost-of-Living Adjustment rider to account for inflation*. 

A policy with a smaller benefit amount, longer waiting period, and shorter benefit period will cost less than a policy with a larger benefit, shorter waiting period, and benefit payments stretching into retirement. Factors such as age, gender, lifestyle, and occupation will also affect your premium costs. One rule of thumb: expect to pay between 1% to 3% of your annual income for a policy that offers the coverage you need. 

The most comprehensive type of disability insurance policy is non-cancellable and guaranteed renewable. That means that as long as you pay your premiums, the insurance company cannot raise your rates, change your monthly benefits or revise policy provisions (such as a Cost-of-Living Adjustment rider) – unless you ask to revise your policy.

Some policies are only guaranteed renewable, with such a policy, the insurer can raise premiums, lower benefits, or change policy provisions – but only if they get approval to do so for the entire rate class from your state’s insurance department.

There is also a conditionally renewable disability policy. With these plans, the insurer can change rates, benefits, and provisions at will, so the policy you get today could cost far more – and cover far less – a few years down the road.

Talk to a professional to explore the right solutions

Disability coverage is one of the most important tools you can have to protect your business and livelihood – but that protection is only as good as the policy contract you sign. Start by talking with your financial professional or a trusted insurance broker. They should be able to suggest possibilities beyond the basic items covered in this article. For example, if you have a few employees, you may be able to have your personal protection needs met with lower-cost group rate disability insurance for both short-term and long-term needs. 

If you don’t have a financial professional or broker, a Guardian financial professional can help craft the right solutions and provide a disability insurance quote. You should be prepared to share as much as you can about your personal and business financial situation and goals so that he or she can tailor your policy and other financial plans to meet your overall protection needs better.

Can I get Social Security Disability if I am self-employed?

Social Security Disability Insurance (or SSDI) is a part of your Social Security benefits, which are paid for by your self-employment taxes. However, it’s usually much harder to qualify for than an insurance policy purchased individually or through a group. Most SSDI applicants are rejected – and the benefits are typically lower than with a private disability policy.² Also, SSDI provides no financial protection for your business overhead expenses – rent, utilities, etc. For most self-employed businesspeople, SSDI is not an adequate source of protection.

Can I buy disability insurance on my own?

Yes. Long term disability insurance policies can be purchased by individuals. A Guardian financial professional can help craft the right solution for you and your business and provide a disability insurance quote.

Are long-term disability insurance benefits taxable?

Since LTD premiums are usually paid for with post-tax income by the individual policyholder, the monthly benefit received is typically free of taxes. You should consult with your financial professional about the specifics for your business.