How to insure your paycheck

Make the most of disability insurance, an important and often misunderstood insurance.

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Odds are you’ve spent long hours finding the right auto or homeowner’s insurance. But what about disability insurance, which would replace lost income if you were unable to work?

“Disability coverage is one of the most ignored insurance coverages out there,” observes Keith Kruk, a Texas-based regional vice president of Fidelity Brokerage Services. “But the greatest asset we have isn’t our home or our car,” he says. “It’s our ability to wake up each morning, go to work, and get a paycheck.”

And disabilities are surprisingly common: One in three women and one in four men will have a disability that keeps them out of work for 90 days or more, at some point during an individual's working lifetime, according to The Life and Health Insurance Foundation for Education. “People need to understand the serious nature of how a physical disability can create a financial disability,” says Kruk.

Cost and confusion

So why is disability insurance so ignored? One reason is cost: Kruk notes that many consumers balk at the price tag for disability coverage, which can cost several thousand dollars a year.

Another reason is that many consumers mistakenly assume that disability insurance is either covered by their employer or provided by the government. While a handful of states require employers to provide temporary disability coverage to employees, most do not. So, it’s up to you to determine whether coverage is available.

State workers’ compensation insurance is only for employees who are injured at work or during the course of their employment. The federal government offers a form of disability coverage through the Social Security program, although meeting the definition of “disabled” can be difficult. It usually requires you to demonstrate that your medical condition prevents you from performing any work, not just your old job. And while many companies offer disability insurance, coverage may be limited regarding which types of disabilities are covered. Or your employer may make it available for you to purchase, often at discounted prices.

Important benefits

Kruk contends that many consumers simply haven’t investigated the benefits of disability insurance. In the case of injury or illness, disability insurance can be a financial lifeline—whether you’re laid up for a week or more than a year. Beyond replacing income, the right policy can help you pay for disability-related costs that aren’t covered by health insurance, from specialized medical equipment to home-based medical care.

What’s more, Kruk says, many people haven’t fully considered the financial cost of not having disability coverage. Without coverage, an injury that keeps you out of work for a week or a month could snowball into a serious financial issue if you don’t have enough savings to support yourself.

The two types of coverage

There are two primary types of disability insurance: short term and long term. Each offers distinct terms and coverage guidelines that are essential to understand before purchasing a policy.

Short-term disability insurance: A short-term policy typically is designed to replace 80% or more of your gross income for a short duration of time. Kruk notes that duration may range from 60 to 180 days, depending on the policy.

For example, if recovery from surgery will keep you out of work for several weeks or months, short-term disability can replace the income you lose while you’re out of work. You typically need to wait for an “elimination period”—say, five or 10 days—before the coverage kicks in.

Employers often offer short-term disability insurance to their employees, and many subsidize that coverage (some pay the full cost). Indeed, 87% of people who own disability coverage have it through their employer. Be aware: If the coverage is subsidized, the benefits are taxable.

California, Hawaii, New Jersey, New York, Rhode Island, and the Commonwealth of Puerto Rico provide short-term disability coverage to workers either directly or through employers. In New York, for example, employers cover the program’s costs, but employees may be required to pay a modest amount toward their coverage. Meanwhile, some state-run temporary disability programs are financed solely through worker contributions. In Rhode Island, employees have up to 1.2% of their salary deducted from their salary (and those contributions are capped to the first $61,400 in income).

State-run disability insurance programs may have different eligibility requirements than policies through private insurers. For instance, Hawaii’s program only covers sickness or injuries suffered outside the workplace (if the disability happened on the job, then the state’s workers’ compensation program would kick in).

Long-term disability insurance: What happens if your short-term disability coverage runs out and you’re still out of work? In that case, you’d turn to long-term disability, which typically kicks in after you’ve been out of work for an extended period of time, such as 180 days.

But long-term disability policies are quite different from their short-term peers. In particular, long-term policies typically cover only about 60% of your salary. Fortunately, the coverage can last for years—even through the rest of your life, depending on the design of the policy.

For example, say you suffered extensive injuries in a car accident and were unable to return to work for nine months: Typically, after six months, long-term disability would begin to replace a portion of your income (or after an elimination period). Once you return to work, the disability coverage will end. Alternatively, say you are diagnosed with a degenerative disease, such as multiple sclerosis, that eventually will make you unable to work. Your disability coverage will continue to pay a portion of your salary for a set amount of time—typically until age 65 or through the end of your life, depending on the policy.

Customizing your coverage

Employers that offer short-term coverage often extend group long-term disability insurance, too, and may subsidize that coverage as well. (Again, if the coverage is subsidized, the benefit will be taxable.) But while short-term disability policies are relatively straightforward, long-term policies are highly customizable. You may want to make changes to an employer-provided policy to suit your particular situation, in which case you may need to shoulder a larger portion of the premium.

Some changes may be worth the extra cost. Kruk tells the story of a heart surgeon who, during a family vacation, suffered a deep cut on his hand that resulted in severed tendons. The accident effectively ended the doctor’s career as a surgeon. While he eventually developed a new career as a medical school professor, his disability insurance continued to pay him a portion of his original surgeon’s salary. The reason: He had elected to purchase “own-occupation” coverage, in which the coverage was based on his ability to continue working at the same occupation. By contrast, “any occupation” coverage considers your ability to work in any job. “Own-occupation coverage is typically for highly skilled people in a specialized occupation,” notes Kruk. “I always recommend that people consider it if they have a specialty.”

Deciding on coverage

When it comes to determining an appropriate level of disability coverage, Kruk recommends first looking at your expenses. How much you spend each month on everything from necessities to creature comforts should give you a baseline of how much you need a disability policy to cover. “The main question is how much it costs you to maintain your lifestyle every month,” he says.

Also consider how long you could get by on your emergency fund (Read Fidelity Viewpoints® How to save for an emergency). Kruk says some people opt not to purchase short-term disability coverage, preferring to self-insure with other assets. Your spouse’s income also may factor into the decision about how much coverage to buy—though Kruk notes that a disability to one spouse may affect the other spouse’s income if he or she needs to stay home to help out with medical care or child care.

Next, review your current coverage to see if it will meet your income needs. You may find that your employer-sponsored long-term disability coverage only covers 60% of your base salary, and that you need to cover at least 80% of your salary to maintain your family’s lifestyle. In that case, consider supplementing this coverage with individual insurance to bridge the gap. Most insurers will look at your earnings and help you calculate how much additional coverage you need to reach your desired income threshold.

Affording the policy

If you’re without disability insurance and are shopping for a policy, start by researching coverage and rates online. But before you buy, Kruk recommends sitting down with an insurance agent or a financial adviser who specializes in insurance to discuss your options. “This is one time when talking to a professional such as an insurance agent can really help you,” he says.

Kruk suggests starting by eliminating the bells and whistles that can raise the price of such policies. For instance, extending the elimination period on both short- and long-term disability can significantly reduce premiums, and you may want to consider how much you are willing to pay for this benefit (which guarantee that your benefit will keep pace with inflation).

Changing the length of a long-term disability policy also can help reduce costs: You may choose to end coverage after just five or 10 years, or you may feel that it’s worth the extra cost to have lifetime coverage. “When it comes to designing your policy, that’s when you try and fit the maximum benefit into the amount you can afford each month,” says Kruk.

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