Introduction to Disability Insurance

Disability Insurance

Protects your most valuable asset and your ability to earn an income.

Disability insurance pays cash benefits to the policyholder in the event the insured is unable to work due to sickness or injury. That cash benefit ranges from 50% to 70% of income. The insurance company will not pay more than 70% of income because there must be an incentive to return to work.

  • If you pay the premium the benefits are normally received free from income tax, if the premiums are paid by an employer, the benefits are taxable as ordinary income.

A disability policy is composed of various elements:

  • Elimination Period - It is the period of time the insured must wait after becoming disabled to receive benefits. Typical waiting periods are 30, 60, 90,120,180, and 360 days. The longer the elimination period the less expensive the policy.
  • Benefit Period - It is the period of time the benefits will be paid following the elimination period. The benefit period could be from 2 years to age 65 to lifetime. The longer the benefit period the more expensive the policy.
  • The Amount of Benefit - The larger the pay-out the more expensive the policy. The benefit will not normally exceed 70% of income.
  • Residual Benefit - Percentage of benefit paid if you return to work and are still partially disabled and cannot return to work full time or cannot earn your full income.
  • Own-Occupation - Pays a benefit if you are unable to return to your present occupation but can work doing something else. For example, a doctor who is a surgeon, cannot return to surgery but can teach. This is the most expensive type of disability policy.
  • Reasonable or Any Occupation - Pays a benefit while disabled, but stops when you are able to return to work at a job that matches your education and experience. This policy is less expensive than an Own-Occupation policy.
  • Occupation - Occupation is a factor used in determining rates. For example, a doctor's rate would be much lower than a blue-collar worker.
  • Guaranteed Renewable - Guaranteed Renewable policies cannot be cancelled by the insurance company even if a change in the insured's circumstances would make him or her a greater risk. Plus, the insurance company cannot make any changes to the provisions of the policy, or add restrictions. When purchasing an individual disability policy it should be Guaranteed Renewable.
  • Non-Cancelable - Guarantees future premiums will not be increased. When purchasing an individual policy it should be Non-Cancelable.
  • Presumptive Disability - Presumptive disability means that you are considered total disabled and eligible for benefits for the loss of sight in both eyes or the loss of two limbs. The better contracts also presume total disability for the loss of hearing in both ears, loss of the power of speech, or the loss of the use of two limbs.
Other Benefits that can be added to an individual disability policy, but could also increase the cost:
  • Protection Against Inflation - A benefit that can be added that offers a cost-of-living adjustment for inflation during a long-term claim.
  • Automatic Increase Rider - Automatically increases monthly benefits for a specified period of time. A typical increase is 5% compound.
  • Future Increase Options - Allows the insured to purchase additional benefit amounts without proof of insurability.
  • Capital Sum Benefit - Pays the insured a lump sum benefit up to 12 times the monthly benefit if the insured loses the sight of one eye with no possibility of recovery or has a hand or foot severed. This benefit is paid in addition to the other benefits.
  • Rehabilitation Benefit - To help a disabled insured return to work, this benefit will pay some of the expenses incurred when the insured enrolls in an approved rehabilitation center. This benefit is paid in addition to the other benefits.
  • Transplant & Cosmetic Surgery Benefit - Under this benefit, any disability arising from donating a transplant organ, improving your appearance or correcting a disfigurement will be covered by the policy.

Types of Coverage

Social Security

Social Security does not just provide for retirement income but disability income as well.

  • In 2014, the average monthly payment to a disabled worker with a spouse and children was $1796. See SSI Fact Sheet
  • Eligibility is based on being unable to perform any gainful employment.See SSDI Disability Planner
  • You are eligible for benefits after you have been disabled for 5 months and if the disability is expected to last 12 months. See Waiting Period Question
  • Social Security disability payments are subject to federal income tax if your income exceeds $25,000 individually or $32,000 jointly. See Tax Question
Workers Compensation

Most employers are required to provide this coverage. The amount and duration varies by state. Workers Compensation only pays if the disability occurs on the job, and usually lasts for only a few years and the payments are low.

Individual Policies

For individual policies, the applicant needs to qualify and go through an underwriting process, similar to the process required for life insurance. The applicant could be subject to a higher premium or even be declined based on his or her occupation, medical history, or lifestyle. Individual policies are usually purchased by high income professionals because of the cost.

Group Policies

Some states require employers to carry group disability insurance anywhere from 26 to 52 weeks.

Group Long Term Disability (LTD)

Group LTD is carried by almost half of mid-size to large employers and provides long term benefits for at least 5 years covering about 60% of salary. The premium is usually very low, does not require proof of insurability, and often is fully paid by the employer.

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