Should You Buy Disability Insurance?When I used to think about disability insurance, it used to be a “yeah, yeah…” subject for me.  In fact, if you asked me a year ago if I should buy disability insurance, I would have told you that I was already covered.

Here’s the problem… I’m really not.

I’ll talk about the “why not” part shortly, but first, let’s dig into what disability insurance is all about…

 

What is disability insurance?

Disability insurance is intended to help cover you in the event that something happens to you rendering you unable to work (partially or fully).

This could be some kind of accident or a sickness that makes it so you can’t perform your regular job duties.

And, if you can’t work, you’d likely want some kind of money coming in to pay your bills.

Disability insurance would be that bridge money coming in to help you.  The insurance payouts are made as periodic payments and are meant to cover a portion of your income.

You might think that it can’t happen to you, but according to the Council for Disability Awareness:

  • Just over 1 in 4 of today’s 20 year-olds will become disabled before they retire.
  • Over 37 million Americans are classified as disabled; about 12% of the total population. More than 50% of those disabled Americans are in their working years, from 18-64.

That’s enough to make me think that this is just as important as life insurance to protect your family!

 

Short-term versus long-term disability

Should You Buy Disability Insurance?Disability insurance comes in two forms: short-term and long-term.

Short-term disability is temporary and usually kicks in pretty quickly after filing a claim for your accident or sickness.  Even though it doesn’t take effect for a week or so, it should be retroactive to the first day of the injury.

It’s meant to cover you for a few weeks to a few months and the policy will generally provide you with 60 percent of your pre-disabled gross salary.

Long-term disability, on the other hand, exists to be able to cover you for longer periods of time – sometimes years.  This policy doesn’t start paying out until any short-term disability coverage is done (3-6 months or sometimes longer).

Depending on the extent of your injury or disease, it may pay full disability (50-60% of your salary) or partial disability (if perhaps you’re able to perform a less exerting job that pays less).

Because long-term disability has the potential for needing to cover you for a long duration, it usually costs more than a short-term policy does.

 

Employer coverage

Should You Buy Disability Insurance?Short-term disability coverage might be offered by your employer.  If it is, that’s great – just be sure to read all the specifics of what’s covered.  The insurance may also be offered at a group rate, which is the case at my place of employment.

Many employers might also offer some type of long-term disability insurance to their employees.  Similar to short-term disability, it might be covered completely by your employer or it might be offered at a discount rate to employees.

In my case, long-term disability insurance is offered by my employer and the premiums are 100%-covered… and because I didn’t read the small print, I thought I was good-to-go.

Here’s why I’m not…

 

The “Gap”

Should You Buy Disability Insurance?No, I’m not talking about shopping at the clothing store – I’m talking about a gap in coverage when dealing with long-term disability insurance.  There can be a gap when talking about short-term disability insurance as well, but it’s generally not as severe and, in most cases, wouldn’t cause as many problems since it’s for a shorter time span.

When I worked with a certified financial planner last year, one of the tasks he asked me to do was to dig into my insurance at work to see if I should buy disability insurance.

Buy disability insurance?!  They already cover me for that!

Then he explained that it’s probably capped at a certain amount and it might not be enough to carry me through rough times.

So I dug into it and guess what?  He was right.  Once disabled for 180 days, the policy through my employer offers a benefit that pays 60% of your pre-disability income, up to $3,000 per month.

Ok, so 60% of my earnings really isn’t that bad – after all, we’re saving around 35-40% of my income right now, so I would just stop my saving and investing during that time and, obviously, cut out some of the non-essentials.

After reading the fine print, though, there are a couple of other caveats that made this not as doable as I initially thought.

  1. The first is that the “60% of your salary” clause is derived from your base salary (which I believe is the case for most policies).  A good percentage of my salary is commission-based so this could be pretty relevant.
  2. The second point to be aware of is most employers (including mine) pays the premiums for this policy using pre-tax dollars.  Because Uncle Sam wants his money, the benefits received would be taxable, thus reducing the weekly benefit.

The first point wouldn’t affect me horribly.  I would still be able to claim the $36,000 per year.  It might be a somewhat uncomfortable, but $36,000 should allow us to pay our regular expenses for a little while.

The problem though is that the payout wouldn’t be $36,000 for the year – it would end up being a lot less after taxes.  When all is said and done, I would end up receiving something like $27,000.  Once we get our house paid off in a handful of years, we’d probably be all right with $27,000 per year, but for the time being, that ain’t gonna cut it!

Score one for the financial planner.  And remember this: you can’t buy disability insurance when you need it – you need to buy it beforehand.

 

Where to buy disability insurance

Should You Buy Disability Insurance?Short-term disability might be offered through your workplace.  If it’s not, or you decide not to buy it, you want to make sure that you have some type of emergency savings in place to cover you for at least 3-6 months at the minimum.

Most employees don’t have enough savings to be able to cover years of salary through their savings, though.  So, if you want to buy disability insurance for the long-term (or even the short-term) to supplement any coverage through your employer, it’s time to shop around.

Clark Howard has a great list of resources to use when looking for an insurer.  AccuQuote, PolicyGenius, and SelectQuote are probably the most well-known sites to find some options for coverage.

You’re going to need to figure out how much coverage you need and for how long.  I would say to focus more on your expenses and less on your salary.  In other words, you need the money to pay your bills – a mortgage payment probably being the biggest concern.

Hopefully, you’re on the path to financial independence and already save a good chunk of your salary.  If that’s the case, you don’t necessarily need to take that amount you save into consideration for the coverage you need.  So, if you’re currently saving 25% of your income, you might not need your entire salary covered.

 

What we’ve decided to do

We’ve decided that we’re going to forgo short-term disability insurance and rely on our savings if it’s ever needed.  We also decided to buy an additional long-term disability policy to supplement the coverage offered by my employer.  Because the policy we’re getting is going to be paid for by us using after-tax dollars, the benefits we would receive would not be taxed.

The supplemental long-term disability policy will run us just under $35 per month and give us an additional $42,000 of annual coverage if needed.  Because we’re on target to reach financial independence in 2025 (sooner if we end up retiring to Panama!) and we’ll have our house paid off around that time, we don’t need a policy for too long.  We’ll likely stop paying on the policy and let it lapse right after we reach FI.

So there you have it – a little bit of info on disability insurance.  Your turn…

 

Do you have disability insurance through your employer?  Have you considered the need to buy disability insurance to help cover a possible gap?

 

Thanks for reading!!

— Jim

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Should You Buy Disability Insurance?

8 thoughts on “Should You Buy Disability Insurance?

  • February 14, 2017 at 4:35 pm
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    I’ve historically passed on disability insurance. The reason being we lived off one income(my income was saved) my wife’s, so I considered us self insured. If something happened to me I could live off her income even if I forgot my work disability insurance. Now that my wife is a stay at home mom there is a bigger risk, but I’m also financially far enough along that she’d have decades to find a job to pay the bills. Ultimately I’ve chosen to self insure. In the same way my life insurance only covers enough years for my wife to settle in and go back to work at this point. (Though that’s approaching enough to retire with given our current savings.)

    Reply
    • February 14, 2017 at 8:33 pm
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      That’s really awesome, FTF – it’s cool that’s you’ve made it to a position to be able to do that. I’m not comfortable enough with our finances to that point just yet, but it’s something we’ll review again in another few years to see if we can join you in that decision! 🙂

      — Jim

      Reply
  • February 15, 2017 at 6:47 am
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    Glad to see this post Jim as I’m currently wrestling with the supplemental disability insurance coverage question. At $35 /month, your policy is way cheaper than I thought it would cost. I thought you could expect to pay anywhere between 1%-6% of the annual benefit each month. Any reason why your supplemental policy is so affordable? Did you find most quotes to be in the $35 range?

    Reply
    • February 15, 2017 at 8:08 am
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      Thanks, Biglaw – most of the quotes I had were probably close to double that cost. However, what really helped bring the premium down significantly was that I had them change the maximum benefit period to be 10 years (as opposed to paying out until my 60s).

      My thinking is that if things go right, I only have 8 years max left at my current employer (and much less if I retire to Panama). Should I need the LTD benefits during that time, we’d still be Ok and even able to save some of the payout, especially with my wife still working. If I got badly injured, we’d be better off with it happening closer to FI than if it would happen in the next couple of months, but we’d still manage to get by without any major problems.

      — Jim

      Reply
  • February 24, 2017 at 12:30 pm
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    Hi Jim,

    This is an important topic and you have written a great post on it.

    #1 Typically short term disability costs higher than long term disability. It all comes down to probability and statistics. That was my observation when I went through the quoting process. For short term disability, some states like NJ provide STD income for a certain period of time. One should check the state laws first. Secondly, if one has emergency funds, that should cover for the short term disability period.

    #2 If you purchased long term disability privately or through your employer using after tax dollars, then the disability income one would receive would most likely be tax free.

    #3 From my perspective, disability insurance is higher in the pecking order than life insurance. Again based on probability and statistics – probability of disability is higher than probability of death.

    I use after tax dollars to pay for LTD and plan to use emergency funds for STD needs.

    –Michael

    Reply
    • February 25, 2017 at 12:53 pm
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      Thanks, Michael! Awesome points you made on this. Looks like you and I have our disability plan in place the same way with emergency funds for STD and after-tax dollars for LTD.

      — Jim

      Reply
  • February 25, 2017 at 7:55 pm
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    We passed on it too but I might have reconsidered if I’d read this post while we were still working. Being covered for the gap seems extremely important. Thanks for the post and also for sharing Clark Howard’s resources.

    Reply

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