Brad Rempe, CFP®, AIF®

Of all the types of insurance an individual may choose to have—life insurance, healthcare insurance, homeowner and vehicle coverage, an umbrella policy, and, of course, professional liability insurance—the one type of coverage that might be overlooked—but shouldn’t be—is a disability insurance policy.

For someone with significant financial responsibilities and a need for a steady income stream to pay for them, disability insurance can be a critical component of your overall risk protection portfolio. An unforeseen disability due to injury or illness that prevents you from earning an income can have a catastrophic impact on your financial health.

If you are unable to earn an income, meeting your ongoing lifestyle expenses either in the short term or long term could force you to liquidate assets you’ve set aside for other purposes, such as investments, your retirement fund or a child’s college savings.

So, what are your odds of “needing” disability coverage? Insurance industry studies indicate that the odds of becoming disabled for 90 days or longer during your working years—and being unable to earn an income during that period—are actually much greater than dying. So, you really need to insure against both unhappy events.

What to look for

How the policy defines disability is an important component of the coverage, because this will determine when you are eligible to receive benefits. Is it “own occupation” coverage, which provides benefits in the event you are unable to perform the duties of your own regular occupation? Or is it “any occupation” coverage, which only pays benefits if you are completely disabled and unable to work in any occupation, regardless of your education and training? (The difference can be a critical distinction: think of flipping burgers or delivering pizzas while you’re trying to recuperate!)

Generally speaking, coverage for long-term disability is limited to approximately 60 percent of your earned income. That means for most policies, rents, royalties, dividends, interest and most other forms of non-job-related income are not included when calculating benefits. So to take a simple example, someone with $100,000 in annual, earned income might expect to receive $60,000 in benefits. But wait—there’s another consideration that affects how much you can receive. Are the policy premiums paid with pre-tax or after-tax dollars? For example, if your employer pays the premiums (with pre-tax dollars), benefits received would be subject to personal income tax. So that $60,000 in benefits—the money you are counting on to cover your expenses and expenditures—may be reduced to $40,000 or $50,000 due to taxes. However, if you pay the premiums with after-tax dollars, the policy benefits are generally not taxable, so you would be eligible to receive the full $60,000 amount.

Another important provision of a disability policy is: how long is the elimination period? This is the waiting period between the time you become too disabled to work and the date benefits begin. Typically, disability policies are written with 30-, 60-, 90- or 180-day elimination periods. Normally, the shorter the elimination period, the higher the policy premium.

As you meet with your personal financial advisor, part of the discussion should center on your specific income needs and how you’d meet those needs during a period of disability. Fortunately, this is an insurable risk and one you can take care of as part of a total package of insurance coverage.

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