How to insure your paycheck

Make the most of disability insurance, a valuable but often misunderstood form of income protection.

  • Long-Term Care Insurance
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  • Long-Term Care 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? There are many types of insurance coverage and riders available in the market, and if you’re considering a purchase you should consult a licensed disability insurance agent. However, if you’re just starting to learn more about the benefits of disability insurance, here are some high level discussion points to consider.

“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 their working lifetime, according to The Life and Health Insurance Foundation for Education.1 “People need to understand the serious nature of how a physical disability can create a financial disability,” says Kruk.

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. Though short- and long-term coverages are "distinct," they are also "complimentary" programs, designed to cover different types of disability.

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), though the subsidized portion may be taxable to the employee.

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% deducted from their salary (and those contributions are capped at the first $61,400 in income).

But most employers operate their short-term program in a way that is uniform across all states (and is designed to be at least as generous as state coverage). State-run disability insurance programs may have different eligibility requirements from policies through private insurers. For instance, Hawaii’s program covers only sickness or injuries suffered outside the workplace. (If the disability happened on the job, 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.

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. 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.

Cost and confusion

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.

A good starting point is to buy the disability coverage offered through your employer. And then consider supplemental coverage offered by your employer, if available. Finally, if that is not enough, explore individual policies.

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.

Analyzing your coverage

Employers that offer short-term coverage often extend group long-term disability insurance, too, and may subsidize that coverage as well. (If the coverage is subsidized, the benefit may be taxable. Consult your tax advisor.) 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 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). 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 whether it will meet your income needs. You may find that your employer-sponsored long-term disability coverage covers only 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.

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 to fit the maximum benefit into the amount you can afford each month,” says Kruk.

Finding the right 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 advisor who specializes in insurance to discuss your options.

Learn more

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1. The Life and Health Insurance Foundation for Education. https://www.lifehappens.org 2014.
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