Nobody plans for a disability. In our experience, people are more willing to incorporate life insurance into their financial plan than disability insurance. Why is this? Let’s first get into the differences between disability and life insurance.
Disability Insurance vs. Life Insurance
Here are a few key differences between these two types of insurance:
- With a life insurance policy claim, your insurance company pays others at your death. A disability income claim pays you, maintaining your family’s financial well-being during an illness or injury.
- Death is a certainty, so your beneficiaries will eventually receive the life insurance death benefit. A disability benefit pays only when you have a covered injury or illness, insuring against the loss of earned income.
- Traditionally, a life insurance death benefit pays beneficiaries in a lump sum. A disability policy typically pays a monthly income to the policyholder — most modern policies pay through age 65 or 67, or to normal Social Security retirement age.
- Many life insurance policies now offer chronic or terminal illness riders, allowing policy owners to draw down part of the death benefit while alive. Many disability policies provide riders that offer a lump sum payment in addition to the monthly income benefit when ill or injured.
- In the private marketplace, both life and disability insurance policies typically provide tax-free benefits.
- Obtaining life insurance involves an application and a health screening exam. Obtaining disability insurance involves that, plus verification of earned income.
Disability Insurance Prevents Financial Devastation to Families
A long-term disability is often more financially devastating to a family than a death. A disability during peak earning years means lost income for potentially decades — without the finality that allows a family to adjust. The longer your remaining work life, the more years of disability risk exposure you carry.
Disability Insurance Definition of Your “Own” Occupation
One of the most important things to understand about disability insurance is that you can receive an income benefit due to an injury or illness, but still continue to work and earn an income. This is possible when the definition of disability is that you can no longer perform your “own” or “regular” occupation. Let me illustrate:
Imagine you are a surgeon who loses a couple of fingers in a freak accident. You may no longer be able to do your job in the operating room. Perhaps you are a civil engineer who contracts a debilitating disease that prevents you from working on a construction site. Both scenarios may prevent you from performing your own occupation, though you may still be able to work in your field in another capacity. The point is, you may be able to double-dip — if you’re that surgeon who lost some digits, you can join a private practice and still receive disability income. The disability definitions are crucial.
“Own” vs. “Any” Occupation
Besides an “own” occupation policy, another definition for disability is “any” occupation. This definition is less protective. An “any” occupation policy pays when you can no longer perform the functions and duties of any occupation for which you are suited by reason of education, training, and experience. Continuing with the surgeon example, a policy likely won’t pay if the surgeon moves to a private practice. It may pay a benefit if he goes into an unrelated field.
Who Should Buy Disability Coverage?
The answer: anyone with an expensive education. What you are insuring is your ability to earn a living. The reasoning is similar to why you should own a life insurance policy: someone else is depending upon you for a living. However, an injury or illness is much more likely during your working years than an untimely death.
Disability insurance is especially important for professionals who recently completed an expensive education — physicians and attorneys come to mind. Perhaps you worked for a few years out of medical school, or you’re out of residency, and you’re beginning to realize a return on your investment. You have a lot of debt. Your biggest asset is your education — your ticket to earning your living. An injury or illness at this point would be financially and emotionally devastating. You insure your home, your car, and your life. Doesn’t it make sense to insure your ability to earn a living?
Riders to Consider
Purchasing a disability insurance policy comes with options to add riders — add-ons that often make a policy stronger.
Residual Disability — This rider pays if you’re partially disabled and working part-time.
Cost-of-Living Adjustment (COLA) — Adds inflation protection to your benefit amount over time.
Guaranteed Insurability Option — Allows for benefit increases through the years with only financial underwriting, no new physical exam.
Note: riders cannot be added after policy placement, so choose carefully at the time of purchase.
Income Replacement Ratio
Policies will cover only about 50% to 60% of your income. You may obtain a higher amount if you are a new professional beginning work and can submit a contract of employment.
Tax Consequences
Generally, if you own a policy on yourself and do not deduct the premium as a business expense, the benefit will be tax-free. This is unlike group plans, where the employer deducts the premium, rendering the benefit fully taxable to the employee. If the benefit is taxable, the income replacement ratio is effectively even smaller — another reason to own an individual policy.
To learn more please read The Difference Between Disability Insurance & Long Term Care.
