Guide to Employee Benefits Open Enrollment 2019 Part 4: Disability Insurance

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Running your household takes a lot of money. From your mortgage to your car payment to your groceries, it all adds up. And we haven’t even mentioned the other expenses you have to maintain your lifestyle like daycare or eating out or entertainment. Now imagine trying to pay for those things without an income and with no ability to earn. How long would your savings last? What would happen once you spend all that money?

That’s why having proper disability insurance in place is important.

Disability insurance may be the number one most overlooked aspects of most people’s financial lives. I think that part of this is because people don’t really understand what disability insurance is or how it can benefit them and how devastating not having it could potentially be on their financial life. Having proper disability insurance coverage in place is something that could provide great protection to you and your family, but that could be devastating without it in place.

What Is Disability Insurance?

Disability insurance replaces part of your income if you become disabled and aren’t able to work. Most people think of a disability as a physical ailment or medical condition which doesn’t allow them to work such as back pain or a heart disease, but this can include mental disorders that prevent you from working as well.

Simply put, disability insurance can be thought of as income protection insurance.

How would you pay your bills and support yourself and/or your family if you weren’t able to work due to a disability and were no longer able to earn an income? Given that we know most Americans don’t have the cash to cover even a small emergency, we know that disability insurance is very important for many people to have in place. Being without an income for a more than a couple of months would be devastating to most people so just imagine if you didn’t have that income for decades and weren’t able to work. You buy homeowner’s insurance, auto insurance, and maybe even life insurance as forms of protection if something goes wrong, so why wouldn’t you protect your income for the rest of your working career with disability insurance?

Disability insurance typically provides you with 40%-70% of your pay if you become disable and can’t work. Why wouldn’t it provide you with 100%? The point of insurance is to make you whole, not to put you in a better position than you were before. Since you have to pay taxes, probably pay for employee benefits out of your pay, and maybe even contribute to an employer-sponsored retirement plan, you don’t receive 100% of your income available to you to spend. The point of disability insurance is not to replace 100% of your income but to get you back to a similar position of your pre-disability take-home pay. Yes, you could qualify for Social Security Disability Insurance, but it’s difficult and it’s highly unlikely to provide the amount of benefits that you need.

That’s why disability insurance is important.

It Won’t Happen To Me

We’d all like to think that we won’t become disabled before we’re able to retire, but chances are that you already know someone who is and/or you will become disabled yourself sometime during your working career. Most disabilities happen to people in their 20s-40s and according to the Social Security Administration¹, “…just over one in four of today’s 20-year-olds will become disabled before reaching age 67.”

Here’s some eye-opening information from the Council on Disability Awareness²:

Three in 10 workers entering the work force today will become disabled before retiring.
One in seven workers can expect to be disabled for five years or more before retirement.
A disabling injury occurs every 2 seconds.

Unfortunately, most Americans have little understanding of the likelihood of experiencing a disability. A recent CDA survey of workers found:

20 percent underestimate their own chances of becoming disabled.
85 percent express little or no concern that they might suffer a disability lasting three months or longer.
56 percent do not realize that the chances of becoming disabled have risen over the past five years.

The Devil Is In The Details

The devil is in the details is a term that financial planners often use when speaking about disability insurance because there are so many different types of these policies and so many different terms that they can contain. This is why it’s important to have a professional help you make sure that the details of your policy are appropriate for your situation and will provide you with the coverage that you need.

The definition of disability is one of these details that is extremely important to understand, but that most people never take the time to read through and carefully consider what their disability insurance policy actually covers.

Definition Of Disability

The “definition of disability” within a disability insurance policy is crucial to know. There are many possible definitions, but the three most common are own occupation, modified own occupation, and any occupation.

An “own occupation” disability insurance policy will pay you benefits if you’re not capable of performing your own occupation, even if you are capable of performing a different job. Imagine if a surgeon hurt their hand or developed arthritis and were no longer able to perform surgery, but they were able to perform other duties elsewhere in the hospital based on their training. They’d likely experience a significant pay decrease so a situation like this is where an own occupation definition could make sense. An own occupation policy can be much more beneficial than an any occupation policy but can also be much more expensive since there’s a higher likelihood that it would pay you benefits. Depending on how an own occupation disability insurance policy is written, you may be able to receive benefits if you return to work in a diminished capacity or in a different occupation.

An “any occupation” definition of disability states that the policy will pay you benefits if you are not able to perform any occupation. You can still be a greater at Walmart? This policy isn’t going to pay. Any occupation is obviously a definition that is not very beneficial to the insured as they’d have to be very significantly disabled to not be able to perform any occupation at all.

“Modified own occupation” definitions often state that the insurance policy will pay benefits for a certain number of months (typically 24) as long as you cannot perform your own occupation, but then will switch to an any occupation of definition after that amount of time. So, if you’re able to perform any occupation after the amount of time written into the policy, then you’ll stop receiving benefits.

Short-Term VS Long-Term Disability Insurance

Many employers will offer both short-term and long-term disability insurance policies to their employees through their employee benefits packages. It’s important to know the difference between these two types of policies and what place each one has in your financial life.

Short-term disability insurance benefits begin after a short waiting period (usually around 14 days) and can last up to a few months. Typically, employer-provided short-term disability insurance policies will work together with the long-term disability insurance provided to make sure that you don’t go without an income and that you switch to benefits from the long-term policy once the short-term policy benefits end.

Long-term disability insurance policies usually have a waiting period of 90 days (how long you have to be out of work due to a disability before the policy will begin paying you) and could potentially provide you with monthly income until your age 65 or Social Security Full Retirement Age, or until you’re no longer disabled. This all depends on what the policy states. For example, if you were to become disabled in your 30s and were no longer able to work you could potentially receive benefits for 30-something years which could possibly be hundreds of thousands or millions of dollars that you otherwise wouldn’t have coming in during that time if the policy allows you to continue receiving benefits into your 60s.

Again, please keep in mind these terms all depend on the what your specific policy states. As mentioned above, not all policies are created equal and the policy offered to you could be much less friendly and could offer benefits for only a certain number of years.

Taxability

If you pay disability insurance premiums pre-tax through your payroll, then you’ll have to pay taxes on the benefits that you receive. If you have 60% of your salary provided as disability insurance coverage and your employer pays the premiums for you, then you could actually end up receiving much less than that after accounting for the taxes that would have to be paid on the benefits.

If you pay disability insurance premiums after-tax either through payroll or through a private disability insurance policy, then you won’t have to pay taxes on the benefits that you receive. This is much more advantageous than paying the premiums with pre-tax money because it could allow you to receive tax-free benefits for potentially decades if you became disabled and needed to use the coverage.

(Some employers offer you the option to pay for disability insurance premiums with pre-tax or after-tax money).

Some employers provide disability insurance to their employees for free, which means that the benefits would be taxable to the employee. Recently, I’ve come across some plans where the employer provides a certain amount of disability insurance to the employee for free (40% for example) and the employee has the option to buy up more insurance up to the policy limits (up to 60% for example). Since the employer is paying for 40% of the benefit that amount would be taxable. However, the other 20% that the employee pays for could either be taxable or tax-free, depending on if the employee pays for the premiums with pre-tax or after-tax money.

I Don’t Want To Pay Another Insurance Premium

Last month, I watched a continuing education webinar hosted by an insurance company where they showed the cost of income protection (AKA disability insurance) as 1-3% of your monthly income. They showed about $95 per month which could be an annual income between $38,000 and $114,000 according to the 1-3% rule of thumb and compared it to date night at $80 per month, daily coffee at a little over $50 per month, and lunch out at $15 per month.

That doesn’t seem like that steep of a price to pay to make sure that you and your family will be taken care of if you’re not able to work. Your income is likely your most valuable asset when considering how much you could earn over your career. No one wants to have to pay insurance premiums, but this is a case where it makes sense and can provide tremendous value if the benefits are ever needed in the future.

Group Vs Private Disability Insurance

Just as with life insurance, it may be prudent to obtain quotes for private disability insurance from an independent insurance agent rather than using all the benefits that your employer offers to you. Although private disability insurers may require you to maximize your employer-provided coverage before providing supplemental coverage or may integrate with the policy in another way, a good independent insurance agent should be able to help you figure this out.

Private disability insurance policies are portable, so the coverage goes with you when you change jobs whereas the insurance you get through your employee benefits ceases once you leave your job. Also, private policies are more flexible and can be written with better definitions for the insured (at a cost, of course), and the benefits will not be taxable since the premiums are paid with after-tax money. The group disability insurance offered to you through your employer may be cheaper, but probably won’t provide definitions as beneficial to you as you can get through paying for a private policy.

Those who have pre-existing medical conditions may find private disability insurance unaffordable. This is where a group policy can have an advantage as they don’t require a medical exam to obtain the insurance and the pre-existing conditions may be covered under the group policy but would likely be excluded under a private policy.

Guide to Employee Benefits Open Enrollment 2019

Far too many people go without proper disability insurance coverage and far too many people face the consequences of doing so. Take a serious consideration of whether you should pick up disability insurance through your employee benefits package during open enrollment, whether you should get a private disability insurance policy, or if a combination of both makes sense.

While this is another form of insurance that we can sometimes perceive as a waste of money when we don’t see any immediate benefits from it, it could provide a massive benefit and help prevent financial disaster if and when the coverage is needed.

This is part 4 of a series where I’m providing general education on many of the employee benefits elections that you’ll be faced with during the 2019 employee benefits open enrollment season. Find the previous posts here: