Disability insurance: Are you really protected?
Your ability to earn an income is one of your greatest assets. So a disability that prevented you from working would be devastating to your financial well-being. Disability insurance can help protect this asset, but not all policies are created equal.
To determine whether a disability policy provides the protection you need, ask the following questions:
What does it cover? Basic disability policies replace a portion — typically 45% to 65% — of your current monthly gross income. But this figure can be deceiving. The portion of your income it replaces depends in part on whether the benefits are taxed. Generally, if you pay the premiums on an individual policy, benefits are tax-free. But if you’re covered by an employer-paid group plan not taxed to you as compensation, benefits are taxable.
Most basic policies impose limits ranging from $10,000 to $15,000 on monthly benefits. Take an individual with a monthly gross income of $25,000 and a disability policy that replaces 65% of that amount. If there’s a $10,000 cap on monthly benefits, then the policy really covers only 40% of that person’s income.
Higher-end policies cover as much as 75% of income and offer substantially higher monthly limits. And some policies pay a lump sum at the end of the benefit period.
How does the policy define disability? How an insurer defines “disability” greatly affects your ability to collect benefits. The most generous policies define total disability as the inability to perform the “material and substantial duties” of your own occupation. That means you would receive full benefits even if you find a job in a different occupation, regardless of how much you earn. So, for example, a surgeon who develops a tremor in her hands and can no longer operate might receive full disability benefits even if she switches to a different medical specialty and earns as much or more than before.
Other definitions may include:
- Modified own occupation, where disability is based on an inability to perform your own occupation. But if you find gainful employment in another occupation, benefits are cut back or eliminated.
- Transitional own occupation, in which benefits are reduced once your total income (including disability benefits and earnings from another occupation) surpasses your predisability income.
- Any occupation, where you receive benefits only if you’re unable to perform the material and substantial duties of any Typically, this is a more difficult threshold to meet.
Note that some policies apply an “own occupation” standard for a specified period (such as 18 months or two years) and then switch to a different standard.
Is partial disability covered? A partial disability can have a significant impact on your ability to work. For example, you might be able to perform your own occupation, but not full time. Some policies offer partial disability benefits, such as a 50% benefit if a disability causes your income to decline by 20% or more, and a 100% benefit if your loss is 80% or higher.
What about benefit and elimination periods? The benefit period can vary dramatically from policy to policy. Some policies pay benefits for as little as one or two years, while others pay benefits until age 65 or longer. The elimination period is the amount of time — usually 30, 60 or 90 days — you must wait after becoming disabled before benefits begin.
Bridge the gaps
To determine your level of protection under a disability policy, review its terms and calculate the gap between your current income and the benefits you’d receive if you became disabled. If the gap is large, consider purchasing supplemental or replacement coverage.