Disability Insurance Basics

Anyone who is gainfully employed, particularly those in prime earning years, AND who relies on their employment income to support themselves and their family, needs disability insurance.

Last week, we began discussing the risk management element of financial planning by covering life insurance. In keeping with that theme, today we’ll talk about disability insurance.

Disability insurance is a bit more straightforward than life insurance. Basically, anyone who is gainfully employed, particularly those in prime earning years, AND who relies on their employment income to support themselves and their family, needs disability insurance. In most cases, with the exception of the financially independent, a person’s job is their primary revenue stream. Disability insurance helps protect that revenue stream should you become injured and unable to work.

Although statistically you are much more likely to use disability insurance than life insurance, especially if you are young, few people have the proper disability coverage. Part of this may be the false assumption that Social Security will cover all disability claims. Unfortunately, this is only true in the most severe disability cases, where you likely will never work any job again or have a terminal condition. For the vast majority of disabilities, you will have to purchase coverage one of two ways - obtain coverage through work or buy your own policy.

The advantage to work coverage is that it is cheap and you can probably get somewhere between 60% and 70% of your gross monthly income protected, which is recommended. The advantage to buying your own personal coverage is that it is much more comprehensive, usually includes partial disability, and you can insure your own occupation. It is also portable, which means you are still covered if you lose your job or switch to a job with lesser or no coverage. The disadvantage is that it is very expensive.

In either case, you should look to cover at least 60% of your gross income. You should pay with after-tax dollars so that any benefit you receive will be tax free, which you will need since you are only getting around two-thirds of your gross monthly income. You should choose a long, three to six month elimination period (the time between your disability and when you begin receiving payments) because you should have enough savings to cover for emergencies. This will help to keep the premiums down. You should also have a payout period of not less than five years and up to age 65 if affordable.

Pursuing own occupation coverage should really be reserved for specialty professions such as physicians, surgeons, architects, etc. As with other insurances, you should choose a company that has high ratings, has a large presence in the market, and that specializes in your particular area.

Tom Orecchio, CFA, CFP, CLU, ChFC, AIF, is the president of Modera Wealth Management, which offers fee-only wealth management services.