Plan For Life
Disability Insurance: The Missing Piece of Your Financial Plan
Key considerations to protect your human capital in the event of sickness or injury.
Five years ago when my wife and I were expecting our first child, I was quick to get term life insurance policies in place. It wasn’t until last year, however, that I protected my human capital from disability.
I’m not alone, either. While most people see life insurance as a no-brainer to protect against losing their income due to death, few people consider protecting their human capital in the event they become sick or injured.
But I’m actually far more likely to become disabled in my working career than I am to die – and so are you.
In fact, the Social Security Administration estimates that 91.2 percent of women and 85.6 percent of men will live to age 67. Meanwhile, the same report projects that a 20-year-old has a 26.8 percent chance of being disabled for at least 12 months before reaching retirement at age 67.
(Note: The definition of disabled in this report is far more strict than you would see in a group or individual policy.)
Once you become disabled, the Council for Disability Awareness reports that the average long-term disability absence lasts 34.6 months – nearly three years!
In other words, our chances of enduring a period of time in which we’re disabled and unable to work is much more likely than the chances of us dying outright. And when you’re in the early or middle stages of your career, there are few (if any) assets more valuable than your ability to earn an income.
Why I Procrastinated on Getting Disability Insurance
When I pictured worst-case scenarios such as losing my limbs or going blind, I always thought I could still perform some (if not most) of the things I do in my job today. I have a rather non-hazardous occupation without the physical labor or heavy machinery that I imagine being involved when I think of becoming severely disabled.
As for all the other bad stuff – from car accidents to slipping on ice – I’m human like everyone else. That means I suffer from optimism bias, or the tendency to believe that bad things are more likely to happen to other people.
When you hear statistics about negative life events, you naturally feel it’s unlikely to happen to you. With this mindset, the price tag for disability insurance seems sky high (and no, it’s not cheap, but we’ll deal with that in a moment).
What I wasn’t considering in delaying the purchase of a disability policy is that terrible, debilitating but not always deadly illnesses like cancer don’t care about your age or occupation. While I was unlikely to be involved in some sort of forklift accident in my work as a financial advisor, I could have easily been diagnosed with a disease that prevented me from working.
In fact, I watched this very thing happen to a client after he was diagnosed with an illness that forced him to leave his job at an inopportune time.
Without the disability policies he purchased outside of his employer, his family would have experienced a dramatic reduction in lifestyle at best. At worst (and probably more likely), they wouldn’t have been able to make ends meet.
Being close to his experience motivated me to finally take action. I got my act together and got the proper disability coverage in place.
Considerations for Disability Insurance
If you’re like me, it may take you a while to land on a policy because of the high costs, myriad of options within different policies, or underlying optimism that you won’t become disabled. Here are a few things that may help with your decision.
1. If you rely on a paycheck, you need to have disability coverage.
Your need is particularly pronounced if you’re married or have children because others likely depend on your contribution to the household.
The need for disability decreases once you accumulate enough retirement savings to make due if a disability forced you into early retirement. If you have children, the need for disability insurance also decreases once they no longer require your financial support.
2. Don’t worry about getting a short-term policy.
You’re much better off creating and adding money to your emergency fund instead of buying a short-term policy. If you already have an emergency fund with several months’ worth of living expenses in it, you can basically self-insure for a short-term disability.
Not only is this approach cheaper, but it provides greater flexibility and liquidity. Long-term disability insurance takes up where the short-term left off and may cover you anywhere from a few years to your entire life time. I recommend seeking a long-term policy that pays benefits until age 65.
3. Figure out what you can afford and get a long-term policy within your budget.
Disability policies come in all shapes and sizes. When you work with a good fee-only financial advisor, they can get you highly customized coverage based on what you are able to afford.
If you’re still concerned about the cost, there are ways to get less expensive coverage. You can consider reducing the monthly benefit amount, shortening the benefit period (the amount of time you receive benefits if disabled), eliminating cost of living adjustments, lengthening the elimination period (the amount of time you must be disabled before benefits are paid), and so on.
4. Don’t underestimate the amount of coverage you need.
Most people think about coverage in terms of their current spending trends, but your medical expenses can skyrocket if your disability forces you to quit your job and your group medical insurance coverage is terminated. You may also need to buy medical equipment or supplies, or in some extreme cases, renovate your home to accommodate a disability.
Childcare expenses are also likely to rise if your children can’t drive themselves. With young children, simply going from two sets of able hands to one might necessitate hiring help with the kids or other household chores like cooking, cleaning, laundry, and lawn maintenance.
5. Don’t assume your employer plan is sufficient.
According to the Bureau of Labor Statistics, about one-third of employers offer a disability policy. Many people don’t buy their own disability policies because their employer is the one that pays for coverage, but these plans only replace a very small amount of income and lack the duration to protect from the average multi-year absence from work.
Employer plans tend to offer a short-term policy covering 60 to 70 percent of your salary with a $1,000/week cap for up to three months. In some cases, employers will offer access to group long-term disability insurance policy covering 50 to 70 percent of your salary with caps between $5,000 and $10,000 per month.
In both cases, these payments are usually only calculated from your base salary while excluding commission or bonuses. If you pay your policy premiums with after-tax dollars, the benefits you receive will be tax free. Premiums paid with pretax dollars, usually through your employer, may cause the benefits to be taxable when received.
Your employer plan alone is insufficient. Plan to purchase your own disability insurance policy, too.
6. Consider purchasing through your employer or a professional association.
Purchasing coverage through a group plan can offer cost savings. Some employers allow you to purchase long-term insurance (beyond the amount of coverage they provide, which is usually not sufficient) as an elective benefit.
In this case, it’s worth purchasing the maximum coverage through the employer’s group plan because it will be substantially cheaper than an individual policy. Similarly, some professional associations (AICPA, for example) offer group disability that is tailored to their profession, which is a good place to start.
Otherwise, you should work with an insurance broker to shop around for a policy with features and pricing that meet your specific needs.
Don't Leave a Gap in Your Financial Plan
Aside from estate planning, disability insurance is the biggest gap in most people’s financial plan. You are more likely to become disabled in your working life than you are to die. This is true even if you don’t work in a hazardous position.
Accidents happen not only on the job but also at home – and illness can strike anyone. If you’re comfortable buying life insurance, you shouldn’t balk at the idea of disability insurance.
Odds are that’s the policy you’ll need if anything goes wrong.
Don’t leave a gaping hole in your own otherwise comprehensive financial picture. Use this as the prod you may need to stop procrastinating and start protecting your most important asset.