Who Typically Needs (Or Doesn't Need) Disability Insurance

Updated

It’s been referred to as “the most important financial product you didn’t realize you needed,” yet only about half of all working Americans own it. It only costs about 1% to 3% of their annual income, and it keeps families in their homes and food on their tables. 

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You’ve probably guessed from the title of this article that we’re talking about disability insurance. And the question asked in the title is somewhat rhetorical in that just about every financial guru on the Internet recommends that everyone who depends on a paycheck have disability insurance.

But is that really accurate? Do you need disability insurance? In this article, we’ll delve into a long-term and short-term disability insurance, talk about who does and who doesn’t need disability insurance, and ultimately help answer the question of if you need it.

Who Typically Needs Disability Insurance?

Before addressing this question in detail, let’s first look at what disability insurance is and the two types of disability insurance available: short-term disability insurance (STD) and long-term disability insurance (LTD).

Disability insurance pays you a percentage of your gross monthly income if you become disabled. According to the Council for Disability Awareness, the most common causes of disability claims stem from:

  • Musculoskeletal disorders
  • Cancer
  • Pregnancy
  • Mental health issues
  • Injuries

Disability is a common cause of people declaring bankruptcy. Even though Social Security Disability Insurance (SSDI) and Worker’s Compensation can offer some assistance to someone who qualifies (which is not easy to do with SSDI), they usually don’t provide enough income to meet all of your expenses, which is what makes disability insurance a critical component of any long-term financial plan.

Short-term disability insurance usually pays benefits for a period of three to six months after a waiting period of 14 days, during which you need to pay your expenses 100% out of pocket. Most STD insurance policies lapse far before the end of the length of the average disability claim, which is about 36 months. 

Long-term disability insurance usually has a waiting period of three or six months, which is why you need short-term disability insurance. LTD insurance policies then pay benefits for a period you select (two, five, or 10 years, or until age 65, or 67).

Both types of disability insurance will usually replace 60%–70% of your gross income during your benefit period. This may not seem like enough to pay your bills, but keep in mind that you don’t pay taxes on the payments you receive, and your living expenses usually decrease when you’re disabled. 

So, who needs disability insurance?

Many professions carry an increased risk of injury. For example, jobs that require manual labor, like construction, factory, and farm jobs, often lead to injuries at work. An employer’s worker’s compensation insurance might cover some of the bills you incur, but that may not be enough. 

But, anyone can become the victim of an unexpected injury. You can slip and fall on an icy sidewall, be involved in an automobile accident that’s not your fault, fall off a ladder, or be injured in countless other ways.

As mentioned above, injuries are the fifth leading cause of disability; the top four have nothing to do with becoming injured. In addition, the Social Security Administration says that about one in four American workers who are 20 years old today will become disabled at some point before reaching age 67. 

Someone who is the sole provider of the family also needs disability insurance. Without their paycheck, the rent or mortgage will be difficult to pay for an extended time, let alone food, utilities, car payments, student loans, and any other recurring monthly expenses. 

It’s estimated that 70% of working Americans wouldn’t be able to survive financially for one month if they couldn’t earn a paycheck. Disability insurance exists to help you make ends meet when the paychecks stop coming in.

People who are self-employed, freelancers, gig-workers . . . anyone who isn’t an employee of an organization that offers group disability insurance as a benefit needs individual disability insurance. Keep in mind that if you have an employer who pays for your disability insurance, the benefits you receive will be counted as taxable income by the IRS – it may make sense for you to pay for your disability insurance on an after-tax basis.

Do You Need Both Short-Term and Long-Term Disability Insurance?

If you work and don’t have six months of living expenses saved in an emergency fund, you need short-term and long-term disability insurance. Many people who buy long-term disability insurance neglect to also purchase STD insurance, which will provide the money necessary for them to pay their bills while waiting for their LTD insurance to kick in. 

Who Typically Doesn’t Need Disability Insurance?

While just about everyone who relies on a paycheck needs some form of disability insurance, there are exceptions. Here are three of them.

You derive most or all of your income from passive sources. If you receive your monthly income from sources that don’t require you to actively generate the income, you may not need disability insurance. These passive sources include things like income from rental property you own, dividends and interest from investments, long-term loans that are being repaid to you . . . any source that wouldn’t be disrupted if you became disabled. 

You’re older and have adequate savings to last until you retire. For example, if you’re five years away from retiring and have enough money saved that you won’t have to raid your retirement accounts, you probably don’t need disability insurance unless you absolutely don’t want to spend down your cash or other liquid assets. 

You own a business, and your business can run without you while still paying you. This is a bit of a riskier proposition because it’s unlikely that your company could continue to operate indefinitely without you, but it is possible if you have a senior management team you can trust and a product that won’t become obsolete. 

Who Can’t Buy Disability Insurance?

Even if you want to buy disability insurance, you won’t be eligible if:

  • You’re retired
  • You’re unemployed
  • You’re uninsurable

It’s also challenging to be approved for disability insurance if you’ve recently struck out on your own, but it can be done. Some life insurance companies will offer you a policy even though you can’t document prior earnings from your business, though they will limit the amount of coverage you can initially purchase. 

Which Is Better: Individual Disability Insurance or Group Disability Insurance?

If your employer offers group disability insurance as an employee benefit, it almost seems like a no-brainer that it would be better for you than an individual policy would be, especially since group disability insurance rates are almost always lower than individual disability insurance rates.

But, there is one crucial consideration for group disability insurance that shouldn’t be overlooked: portability. Group disability insurance is generally not portable, meaning that if you leave your employer, you can’t bring your coverage with you. 

This can be a problem if your health has declined to the point where you may no longer qualify for an individual policy and because your rates will have gone up because you’re older – individual disability insurance rates are determined by your age when you are issued the policy. 

The advantage of group disability insurance is that it is “guaranteed issue,” meaning that, regardless of your health history and any pre-existing conditions you may have, you will be automatically approved when you apply through your employer. 

Alternatives to Disability Insurance

There are two alternatives to group or individual disability insurance: Social Security Disability Insurance (SSDI) and worker’s compensation. Here’s a bit of information about both. 

SSDI has two significant drawbacks. 

The first is the difficulty of having your claim approved. According to the Social Security Administration (SSA), the average acceptance rate of initial applications is 22 percent, and approximately 63 percent of SSDI applications are ultimately denied. It isn’t unusual for the SSA to take six months to render a decision, during which time you probably aren’t receiving a paycheck.

SSDI’s other big negative is the benefit payment amount. In 2022, the SSA has set the maximum monthly benefit to $1,358, which is barely above the poverty level set by many states. In most metropolitan areas in the United States, this monthly benefit would probably not cover the cost of an apartment. 

Worker’s compensation is another means of providing income while you’re disabled, but only if your disability was caused by an injury sustained on the job. Some estimates put the first-round claim denial rate at upwards of 25%. 

Disability Insurance and COVID-19

While it is improbable that SSDI or worker’s compensation will cover the coronavirus, disability insurers are paying short-term and long-term claims for COVID-related disabilities. 

If a doctor or other medical professional verifies that you’re unable to work because of COVID, you can claim short-term disability insurance benefits. A medical quarantine issued by your provider is a qualifying reason, but not a social quarantine, like those issued by local, state, or federal governments. 

If you suffer complications from COVID that keep you out of work for 90 days or longer (varies by policy), you may be able to claim LTD insurance benefits. 

Disability insurance policies won’t cover you if you lose your job and income because your employer couldn’t stay open during COVID, either permanently or temporarily. 

How Much Disability Insurance Do You Need?

If you’ve decided that you need disability insurance, you want to be sure you have enough protection to pay your ongoing monthly expenses. Consider these four factors when determining how much disability insurance you need:

Coverage amount: STD insurance replaces as much as 80% of your gross monthly income, while LTD pays around 65%. Make sure your benefit amount not only covers your bills and immediate expenses, but also allows you to keep saving money and funding your retirement. 

Duration: Since the average disability lasts around three years, experts recommend you buy a policy that pays you benefits for at least five years, though a policy lasting until retirement will provide the maximum amount of protection you’ll need, especially if you suffer from an ongoing or recurrent illness.

Elimination period: Also known as a waiting period and operating much like a deductible with a health insurance policy, this is the amount of time from when you become disabled and when benefit payments begin. Financial advisors and insurance agents specializing in disability insurance recommend a 90-day elimination period as the most cost-effective option.

Cost: Depending on how you configure your policy and which options you choose, you can expect to pay 1% to 3% of your annual income for coverage. 

A Final Thought

You can use the monthly check you receive from your disability insurer any way you see fit. Not only can you use it to cover everyday expenses and pay your monthly bills, but you can also keep up with your long-term financial plan. If you need a paycheck, disability insurance will protect your most valuable asset – your ability to earn an income. Get with your financial advisor today to determine what your disability insurance needs are, as well as to calculate how much life insurance you need.

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