Protecting Your Ability to Earn: a Note on Disability Insurance

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“What is your most important financial asset?”  Many will respond with “My home” or “My savings”.  In many cases however, an individual’s most important financial asset is really their ability to earn an income over a 40 to 50-year career.  And, it is an asset well worth protecting.

Whereas life insurance is designed to protect others from financial hardship when the insured person passes, disability insurance is designed to protect the insured person and their family if their ability to earn an income ceases as a result of accident or illness.

We find it interesting that we often consult with clients who have been very thoughtful about ensuring they have adequate life insurance coverage, yet have given little thought to whether they are appropriately insured in the event they are unable to work.  This is somewhat ironic as, at any given point in time, the probability of becoming disabled may be greater than dying.

Disability Plans – Things to Consider

If you are an employee, you likely already have some kind of disability coverage through a company-sponsored provider. It’s important to get a clear understanding of your plan’s features to gauge whether the policy benefits are sufficient to maintain your preferred standard of living.  Coverage differs greatly from one plan to another, but usually provides a benefit of about 60% of monthly income.

In some cases, employee disability plans may have a cap on the benefit payment regardless of the employee’s income, so a ‘high-income earner’ may want to consider a supplementary private plan to complement any group coverage already in place.   In other situations, an employee may want to consider opting out of their company disability plan entirely by purchasing their own independent disability plan.   The benefit of the latter approach is that your disability policy won’t be tied to your current employment so you will be able to maintain coverage even in you become unemployed or switch jobs, provided you continue to pay your premium.

Other points to consider when determining an appropriate amount of disability insurance coverage include:

  • Benefit payments should prevent any possibility of defaulting on existing loans.
  • The policy should pay out enough so all fixed, non-discretionary expenses are covered.
  • The policyholder may also want to continue saving for goals that will require significant future funding, like tuition for dependents.

There are several factors that contribute to the cost of disability insurance.  Not surprisingly, the more you wish to receive in monthly benefits, the higher the policy premiums.  Those who work in high-risk occupations (construction workers or trapeze artists, for example) and those with pre-existing health issues will also pay more.

One way to reduce the policy premiums is to build in a longer ‘waiting period’, which is the time lag between which your disability claim is first filed and when the benefit payments actually begin.  Most budgeting experts recommend having sufficient savings to cover five or so months of household expenses.  Tapping this rainy-day fund while waiting for your benefits to start will help lower premiums.  Younger applicants generally pay lower premiums as well.

Disability plans may provide coverage for “any occupation” or “own occupation” income levels.  Here too, high-income earners will usually find “own occupation” coverage is the better choice.  “Any occupation” means that if you become disabled but are still able to perform a less demanding (whether physical or mental), lower-paying job, the benefit payments from an “any occupation” plan may not be enough to support a preferred lifestyle.

Further, more expensive plans will offer a cost-of-living adjustment, meaning benefit payments adjust with inflation.

Finally, it is important that individuals pay their own disability insurance premiums as disability benefits become taxable to an employee when an employer pays the premiums.  This situation should generally be avoided as an employee is only covered for about 60% of their gross income to begin with so avoiding losing more of your income replacement to taxes is important.

While Bridgeport does not offer insurance directly, we often work with independent insurance advisors to ensure appropriate coverage for our clients and we are also able to recommend a number of excellent insurance professionals with whom we frequently work should you require a referral.