How Much Short or Long-Term Disability Insurance Do You Need?

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Along with life insurance and health insurance, disability insurance is a critical tool for protecting your family’s financial future. Some financial advisors consider it the most valuable type of insurance coverage you can own because it helps replace your income while you’re still alive and with your loved ones.

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In this article, we’ll briefly review what disability insurance is (short-term and long-term), answer the important question of how to determine how much disability insurance you need, look at the cost of coverage, as well as answer other FAQs about disability insurance. 

What Disability Insurance Does (Short- and Long-Term) and Why You Need It

Put simply, disability insurance replaces a portion of your income when you’re injured or too sick to work, which is why it’s sometimes called “disability income insurance.” The insurance company will pay you a monthly benefit which you can use any way you see fit, like supporting and maintaining your lifestyle, from mortgage payments to utilities to groceries.

Financial planners almost universally tell their clients they need disability insurance because the chances of becoming disabled are much greater than people think. According to the Council for Disability Awareness, over 25% of today’s 20-year-olds will become disabled before they retire. 

And, accidents are not usually the cause of a disability, contrary to what most people think. Instead, back injuries, cancer, heart disease, and other illnesses cause the majority of long-term absences from work. 

Most disabilities are temporary in nature, keeping people out of work for under a year. Short-term disability insurance (STD) is often an employee benefit available from medium-large size employers. STD usually pays benefits for 3–6 months after a 14 day waiting period.

Unfortunately, many other disabilities are more severe and long-term, lasting just under four years, according to the Council for Disability Awareness. Though long-term disability insurance (LTD) is also available through some employers as a group benefit, it’s also often purchased individually by higher-income professionals (physicians, attorneys, etc.).

How to Determine How Much Disability Coverage You Need

The easiest way to answer the question “How much disability insurance should I get?” might be either “As much as you can” or “Enough to replace all of your income.” But, when it comes to disability insurance, you won’t find a policy like that. 

Disability insurance policies are designed to replace a portion of your income, not all of it. Insurance companies won’t replace your whole paycheck because they want you to have an incentive to get back to work. Therefore, most policies will replace anywhere from 60% to 80% of your income, depending on a number of factors. 

Here are some questions to help you decide how much disability coverage you need.

What are your current expenses? This is pretty straightforward to figure out. First, look at your monthly take-home pay, then calculate how much you have leftover at the end of the month. So, if you take home $6,000 a month, save $700, and give another $300 to charity, your actual expenses can be pegged at $5,000.

What spending changes will you make if you become disabled? Many financial advisors believe that you’ll need between 60% and 70% of your current expenses because you won’t be spending as much money as you did when you were working. Why?

  • You won’t have commuting costs
  • You’ll be spending less on lunch and coffee breaks
  • You’ll be investing less in your wardrobe
  • You’ll be paying less in taxes

Can your spouse generate more income? If you’re confined to your home, you may be able to assume more of the household responsibilities. This could free up more time for your spouse to work, erasing some of the family’s income shortfall.

What other income, savings, or assets can your draw from? For example, if you’ve been saving money for something like a dream vacation or a second home, you could redirect that money to help pay living expenses. Also, you might have passive income from rental property you own or investments that generate dividends. Similarly, if you have a medical or legal practice and own your own office, you might be able to rent that space out to another practitioner. 

After answering these questions, enter the numbers into this simple formula:

Your total current monthly expenses minus

Reduced spending each month minus

Monthly income from other sources equals

Your minimum monthly disability benefit

How Much Should You Expect to Pay For Disability Insurance?

A good benchmark to follow is a long-term disability insurance policy will cost 1% to 3% of your gross annual income. There’s such a significant range because there are many variables that determine your risk of becoming disabled and the potential benefit you could receive, including your:

  • Age
  • Health condition
  • Occupation
  • Income
  • Monthly benefit amount
  • Elimination period (how long you wait until benefits begin being paid after you suffer a disability)
  • Benefit period (how long you receive benefits, which can range from 2, 5, or 10 years, to age 65 or age 67)

The definition of disability written in your policy will also significantly impact your premiums. 

An any-occupation definition means you’ll qualify for benefits only if you can’t perform any type of work. For example, a surgeon who can’t operate because of debilitating arthritis could teach at a medical school, which would negate them from receiving any benefit payment. 

An own-occupation definition means benefits will be paid if you can’t perform the duties of your specific occupation. The surgeon in the example above would qualify for benefits since they could no longer operate, even though they could engage in another occupation. 

Because benefit payments are more liberal under an own-occupation policy, they will have significantly higher premiums than any-occupation policies. 

Riders will also affect your premiums. These are optional benefits you can add to your base policy, allowing you to tailor your policy to meet your specific needs. Some of the riders life insurance companies and disability insurance companies make available are:

Cost of living adjustment rider (COLA): This rider helps your monthly benefit amount keep pace with inflation through an annual percentage adjustment each year you’re disabled and eligible for the payment of benefits.

Basic or enhanced partial disability benefit riders: protects you by paying a partial benefit if you suffer an illness or injury that limits your ability to perform some of your job responsibilities but doesn’t cause total disability

Student loan protection rider: provides an enhanced benefit to help you make student loan payments while you’re receiving monthly benefits. This is a valuable rider for professionals early in their careers who assumed large amounts of student debt.

Future purchase option: lets you increase your coverage in the future as your income increases, without being required to have a medical exam or provide evidence of insurability

How to Get Disability Insurance

There are two ways to get short-term and long-term disability insurance: through your employer or as an individual. 

Many medium to large-sized companies and organizations offer both STD and LTD as part of their benefits package. Getting disability insurance protection as a group member can be advantageous since group insurance premiums are typically lower than those for an individual policy. In addition, some employers also pay a portion of their employee’s premiums, further reducing your cost.

However, there are a couple of drawbacks to group disability insurance coverage.

First, your policy isn’t portable, meaning that if you leave the group, you can’t bring your coverage with you. This can be problematic if your health has declined since you started with your employer, which may make it difficult for you to be approved by an insurer for individual disability insurance coverage. 

The other drawback to getting your coverage through a group is that your rates will be higher when you leave and apply for new coverage elsewhere because you’re older than when you enrolled in your previous group disability insurance coverage.

Buying an individual policy can be a better overall value since it’s tailored to your individual needs. You also don’t have to worry about portability and losing your coverage. Individual disability insurance policies are also non-cancellable and guaranteed renewable, meaning your policy will remain in force for as long as you pay your premium. And, your rates won’t ever increase, which they can with group disability insurance. 

There is one other significant difference between employer-provided disability insurance and individual disability insurance. If your employer pays part or all of your monthly premiums, a portion or all of your benefit will be considered taxable income by the IRS, reducing your net benefit.

Since individual disability insurance is purchased with after-tax dollars, none of your benefit payment is taxable, meaning you’ll net a higher amount to pay for your living expenses. 

Frequently Asked Questions About How Much Disability Insurance People Need

Don’t I already have some disability coverage through Social Security?

Social Security Disability Insurance (SSDI) is part of your Social Security benefits and will pay a benefit if you’re declared totally disabled. However, it is extremely difficult to qualify for benefits compared to group or individual policies issued by private insurers. 

According to the Social Security Administration (SSA), only 27% of SSDI claims are approved yearly. In addition to it being very difficult to be approved, it can take months before you get a decision concerning your claim. Group or individual disability insurance can keep money coming in while you’re waiting for a decision from the SSA.

If I have long-term disability insurance, do I still need short-term disability coverage?

Since most disabilities are short-term in nature, you should carry short-term coverage. For example, if you had no income for 3–6 months, would you or your family face financial hardship? For most families, the answer is yes.

According to Life Happens, 70% of working Americans say they couldn’t survive more than a month without a paycheck before experiencing financial hardship. Short-term disability policies typically begin paying benefits after you’re out of work for 14 days.

When should I begin thinking about canceling my disability insurance coverage?

Some people begin thinking about canceling disability insurance once they’ve reached a place where they continue working but no longer rely on their income to pay their bills. They have often worked for many years, no longer have a mortgage, and have paid off their children’s college.

You can also safely drop your coverage if you’re retired and no longer working since insurance companies won’t pay claims to replace your income if you no longer have an income. 

Talk With Your Financial Advisor About Disability Insurance

If you use the services of a financial planner or other financial advisors, talk with them about incorporating short-term and long-term disability insurance into your financial plan. All of your financial goals and dreams can come to an end if you lose your paycheck from becoming disabled. Disability insurance may be just what you need to have peace of mind knowing that a secure retirement and a college education for your kids will one day become a reality, even if disability strikes.

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