Disability Insurance

Understanding disability insurance in 2016. What is disability insurance and how does it work.

Of all the different types of insurance policies that people need to protect themselves, their family and their property, the one that is most overlooked is disability insurance.

Some dismiss it because of their feelings of invincibility; a debilitating injury or illness “won’t happen to me.”

Others believe they’re covered through other means, whether by their health insurance, government benefits or through their employers.

But serious injury and illness that prevent people from working for a period of time do happen to a large percentage of the population, regardless of how healthy they may be.

And those potential sources of coverage may only replace a small fraction, if any, of a person’s income. For example, worker’s compensation only covers accidents and illnesses resulting directly from your job. According to the Social Security Administration, less than 4 percent of disabling accidents and illnesses are work related. The remaining 96 percent are not covered by workers compensation.

Speaking of Social Security, the program does offer disability insurance for workers, but nearly two-thirds of applicants are initially denied. Those who do receive coverage receive a monthly benefit averaging around $1,200.

Why you may need disability insurance
The main purpose of disability insurance is to replace a major portion of your income if you are unable to work due to injury or illness. The payments you receive can help protect your lifestyle through the period you cannot work.

Estimates range from 25 percent to 30 percent of American workers will endure some type of temporary disability during their careers that will prevent them from working. What’s more, a 2015 study by The Pew Charitable Trust found that 55 percent of American households can replace less than a month of their income with their current savings.

That means without disability insurance, the majority of households hit with lost income due to a temporary disability will face the prospect of falling behind on their mortgage or car payments. They may be forced to rack up thousands of dollars in credit card debt. And they may have to sell valuable items or tap into retirement accounts for needed cash.

Disability insurance basics
Disability insurance is divided into two categories: short-term and long-term.

Short-term disability insurance is usually provided by employers and covers individuals, on average, for about six months. Some policies might cover lost income for up to a year. Policies typically reimburse about 60 percent of your lost wages due to disability.

Long-term disability policies are designed to protect people from catastrophic illness or injury that keep them out of work for an extended period. These plans usually pick up where a short-term disability policy would end. Benefits may last from five to 10 years, and some policies will pay up until the insured reaches age 65.

There are also a couple of variations on the traditional disability insurance:

Accident-only policies, which provide a monthly benefit only in the event you can’t work due to an accident. It does not cover disability caused by an illness. As such, this type of policy costs less than a normal disability policy.

Business Overhead Expense Insurance. This type of policy is designed to help business owners maintain their business in the event they become disabled. Whereas regular disability insurance covers individual income, a business overhead expense policy will help cover monthly business expenses such as employee salaries, rent, utilities, maintenance, taxes, etc. Premiums for this type of insurance are considered a business expense and are therefore tax deductible.

What constitutes disability will depend on the policy. Some policies will pay out a monthly benefit if an injury prevents you from working at your normal job, but allows you to do other types of work. For example, if a construction worker hurts his back in a non-job-related manner, he or she could perhaps work a lower paying retail job. In that event, the policy would still pay a monthly benefit because the injury has reduced the injured person’s income.

On the other hand, many disability policies will only pay a benefit if the individual is unable to work in any capacity.

How are premium amounts determined
In addition to the type of disability insurance you buy and the definition of disability used, several factors affect the cost of a policy. Individual disability insurance is underwritten much like life insurance and will take into account:

Age and health.
Insurance is more costly for older individuals and those with health issues. People who smoke will also be charged more.
Women tend to file more claims and will, therefore, pay more in premium.
People with high-risk jobs that could cause injury will pay more for insurance.
Income. Since the insurance policy pays a percentage of your income, the more you earn, the more you will pay in premium.
Length of waiting period.
The waiting period on a disability policy is the amount of time between when you become disabled and when benefits kick in. For example, a policy may have a 60-day waiting period. If you get hurt on January 1, you won’t receive a benefit for 60 days after that date.
Benefit length.
You can choose how long the policy will pay in benefits. The longer you receive payments, the more you pay in premium.
Extra features. Many policies have add-ons such as cost-of-living adjustments that require extra premium.

Unlike health insurance, premiums for individual disability insurance are not tax deductible. The benefits you receive, however, are tax-free unless your employer pays the premiums.