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Insuring Your Own Earning Power

Editor’s Note: This article is adapted from “Medical And Disability Insurance,” Chapter 9 of The High Achiever’s Guide to Wealth. Pick up your own copy here to read more on this topic, and many others.

Young professionals often undervalue their most valuable financial resource: their ability to make a living.

For adults who support themselves, losing the ability to work is one of the greatest risks to financial stability. Not every illness or injury means your working life is permanently over, of course. Your disability may be temporary, or you may adjust to your new level of ability in a way that allows you to return to work or pursue a new career. But illness or injury can mean that you need to move to part-time work, or take you away from the workforce entirely for a year or more.

Even a robust emergency fund generally covers three to six months of living expenses, and many people have much less than that saved. And while medical insurance will help you bear the cost of hospital stays, physical therapy and other treatment related to your illness or injury, it will not replace your income. Without disability insurance, the expenses of daily living can eat through any savings cushion you’ve set aside. You may have to take on burdensome credit card debt if you run out of savings, or the financial burden may fall on your family or friends. Disability coverage can remove this prospective stress.

Types of Disability Insurance

Disability insurance comes in two major categories: short-term and long-term disability. Short-term coverage generally lasts for up to six months, though occasionally a policy will last as long as two years. The monthly premiums are sometimes a bit lower than long-term policies, but in general the difference isn’t substantial. These policies are common as employer benefits, but rare as individual policies. If you aren’t already getting disability insurance at work, buying a long-term policy will likely prove more straightforward. Long-term disability coverage can provide benefits for life or until the insured reaches a certain age, such as 65 or 70.

Disability insurance policies usually pay between 50% and 70% of your lost monthly gross wages, though some policies go as high as 80%. Short-term policies typically replace a higher percentage of lost income than long-term policies do. Insurers don’t provide full replacement because they want to give the policyholder an incentive to return to work if possible. According to the Council for Disability Awareness, the average duration of a long-term disability claim is about 35 months.

In either short-term or long-term policies, benefit payments may be taxable or tax-free. The difference is not the length of coverage, but the way you pay your premiums. If you use pretax funds, or if your employer paid for your coverage, benefit payments are taxable income. If you paid your premiums with after-tax dollars, payments aren’t subject to income tax.

Where To Get Disability Insurance

If your employer offers disability insurance, getting it at work is usually easiest. LIMRA, an association of financial service companies, found in a 2017 survey that 41% of employers offered long-term disability insurance as a benefit. If your employer covers some or all of your premiums, you are likely to get the most value participating in this plan. Even if you are responsible for all or most of the costs, you may get a better deal through a group plan at work than by shopping as an individual. A work plan may also offer the option to pay premiums with pretax dollars, reducing your taxable income. If your employer offers short-term disability coverage at low or no cost, consider it as a complement to an individual long-term policy.

Even if you can’t access a workplace plan, you may have access to a group plan through a membership organization or association. Common examples include labor unions and medical or legal associations. As with an employer-provided plan, take care to determine what coverage the group plan does and does not provide. Despite relatively low premiums, this plan may not offer as much coverage as you need.

Depending on where you live, you may have access to some level of coverage provided automatically. At this writing, five states – California, Hawaii, New Jersey, New York and Rhode Island – offer state disability insurance. Benefits are funded by paycheck withholdings, and all five states require workers to have contributed to the fund for some set amount of time before they are eligible for benefits. These programs generally offer short-term coverage, ranging from 26 to 52 weeks of benefits. While the programs aren’t meant to be a substitute for long-term insurance, you should be aware of the details of your state’s program so you can claim any benefits you may be due. Social Security also offers disability benefits in certain circumstances. However, these can be hard to claim successfully, and benefits are relatively small even for individuals who succeed. Use state programs and Social Security to supplement, not replace, other coverage.

If you can’t get long-term coverage at work or through a group plan, or if these options don’t provide the coverage you want, you may end up shopping for individual long-term disability coverage. Third-party websites can provide information for comparison shopping. Or you may want to work with a professional who can help you compare various quotes. Depending on your needs, you can work with a fee-only financial adviser, an independent broker or an online insurance agent. Disability prices are fixed by law, so be aware that working through an independent broker will not cost more than buying a policy directly from an insurer.

It is worth noting that a preexisting health issue is not always, or even often, a problem in obtaining individual disability coverage. Depending on the issue, it may not affect coverage at all. In other cases, the condition may be exempted, but you can get coverage for unrelated illness or injury.

How To Choose A Disability Policy

The first consideration when shopping for disability coverage is what the policy includes. In most cases, you should look for a policy that covers both accidents and illness. Accident-only policies exist, and their premiums are usually cheaper than more comprehensive options. But for most workers, they do not provide enough coverage.

More broadly, you should make sure you understand a policy’s definition of disability. There are several common types of definition, though particulars vary. Some policies use the same definition as the Social Security Administration. This definition is restrictive: To qualify for benefits, the insured cannot be able to engage in any substantial gainful employment. The disability also must have lasted for at least five months, and must be expected to last at least 12 months more or to result in the insured’s death.

Broader disability definitions include “any occupation,” in which the insured receives benefits if he or she cannot engage in any reasonable occupation based on his or her education, experience or training. In other words, even if you can no longer do your old job, if you can reasonably perform a different job the insurer will not consider you disabled. In contrast, “own occupation” bases an assessment on the insured’s ability to resume his or her original work. Such a policy will be more expensive, but can make sense in some scenarios. If a neurosurgeon injures her hands and can longer perform surgery, she may still be able to teach or secure some other related position. But she has still lost a major portion of her former earning power. There is no single right answer to the balance between a more expensive policy and a more generous definition of disability, but you should make sure you understand the trade-offs in advance.

Some policies provide benefits for partial disability. (These may also be called “residual benefits.”) The definition for partial disability, like full disability, will vary between insurers and policies. It may also depend on the insured’s occupation. Policies that include partial disability benefits can support a transition to part-time or less lucrative work after a serious illness or accident.

When shopping for a long-term policy, note the policy’s duration. In most cases, you should look for a policy with a benefit period of at least five years. Less than this will leave you at risk of running out of benefits during even an average illness or injury recovery. Whether you want more than five years of coverage will depend on your financial circumstances, your family health history and how much you value the peace of mind a longer benefit period can offer. A policy that provides benefits until retirement offers maximum protection, but comes with higher premiums. Regardless of the term you settle on, take special care to note whether your policy applies a distinction to disabilities based on mental illness; many policies limit benefit payments for these claims to a shorter period.

You should also look at the “elimination period,” a waiting period before the insurer will start to pay benefits. Common elimination periods are 30, 60, 90 or 180 days. Long-term disability coverage usually involves a longer elimination period than short-term coverage, but particulars vary. Longer elimination periods often translate into lower premiums, but they mean that you will need sufficient funds to cover the time while you wait. When you do this calculation, you should add an extra 30 days to the period specified. Most insurers pay benefits at the end of the month after the elimination period ends. If you have short-term disability coverage through your employer, you may not need to worry as much about the elimination period on your long-term policy, since the short-term coverage could cover the gap.

Younger shoppers may want to look for policies that guarantee noncancelable coverage. This feature ensures the carrier will not raise rates or cancel your policy unless you stop paying premiums. Such a policy allows you to lock in a reasonable long-term rate. A guaranteed renewable option is a similar feature; an insurer cannot change or cancel a policy if the insured stays current with premiums, though in contrast to noncancelable coverage, the rates can rise upon renewal.

You should also look for the policy’s cost-of-living adjustment, if present. A COLA feature increases monthly benefits by an amount based on inflation. Especially in a long-term policy, this feature ensures that inflation doesn’t eat away at benefit payments’ real value over time. You may also want to look for an additional purchase benefit, which will let you purchase more insurance at set intervals without having to prove your insurability again. Especially for younger adults, this feature can make sure your coverage keeps up with your increasing earning power. If a policy lacks either of these features, you may be able to add them as riders.

Make sure you understand whether and how a prospective policy will interact with Social Security or workers’ compensation. Some policies stipulate that benefits received under these programs will offset insurance benefits. Even if your policy includes such restrictions, however, it does not render disability insurance a bad idea. Your policy could easily have a wider definition of disability than the Social Security Administration, meaning you could qualify for benefits in situations where Social Security would not pay them. And workers’ compensation only covers injuries that happen on the job; accidents that happen elsewhere, and illnesses of any kind, are not covered.

For most, cost is a major factor in selecting a disability policy. In addition to the factors I’ve already mentioned, your occupation, age, sex and state of health will affect premiums. Prices also vary depending on where you live. As a good rule of thumb, look for a policy with annual premiums between 1% and 3% of your gross income.

If you did not work with a financial adviser or broker during your search, it is a good idea to have an expert look over the policy you have selected before you sign. An adviser or an attorney can help you spot an irregularities or provisions that might trip up a future claim. An adviser can also help you evaluate an insurer’s financial stability and reputation.

Once you have disability coverage in place, plan to revisit your coverage periodically. You should also review it whenever you experience significant life events, such as the birth of a child, a move across state lines or a major promotion. As with any insurance product, resist the urge to “set it and forget it.” But in the meantime, enjoy the peace of mind that comes from knowing you have insured one of your most valuable assets: your own earning power.