Disability Insurance – How Much Do You Need?

Having robust disability insurance provides essential income replacement if injury or illness prevents you from working. While no one likes to think they will become disabled, statistics show 1 in 4 workers will be out of work for at least a year due to disability before retiring.

Yet even full-time employees often lack adequate disability coverage. For self-employed individuals or small business owners, the risks are even greater. Understanding how disability insurance works, typical costs, and factors in determining sufficient coverage can help you protect your finances during turbulent times.

This guide will walk through key considerations in choosing disability insurance policy types, benefits, benefit periods, and income replacement percentages tailored to your profession and lifestyle needs.

How Disability Insurance Works

Disability insurance provides partial income replacement if injury, chronic condition, or sickness stops you from being able to work. Policies pay monthly benefits after an initial waiting period when disability is confirmed. Benefits continue paying according to policy terms as long as you remain disabled per the contract definition. Exact qualifications depend on the type of policy and rider options selected.

You pay premiums based on age, occupation risk, income amount to insure, and other factors. If never disabled, you receive no payout. So having sufficient coverage to replace income if catastrophe strikes is crucial.

Employer Provided Disability Insurance

Some employers provide access to group short and long-term disability plans as benefits. Key attributes:

Short-Term Disability

Replaces 40-60% of income for 3-6 months
Covers disability from illness or injury
Costs range from 0.3% to 0.8% of salary

Long-Term Disability

Replaces 40-60% of monthly pay after short-term coverage ends
Benefits continue paying until retirement age or recovery
Cost is typically 1-3% of monthly earnings

While helpful, employer disability plans often have gaps like low payouts insufficient to maintain lifestyle and exclusions requiring supplemental individual coverage.

Individual Disability Insurance

Purchasing your own policy allows customizing benefits and filling gaps from employer’s plan. But requires qualifying medically based on health history.

Benefits

Choose monthly payout you need vs. fixed percentage of pay
Add cost of living adjustment and other riders
Lock in affordable premiums when young and healthy

Considerations

Pre-existing condition exclusions may apply
More health history scrutiny to qualify than group plans
Must continue paying premiums if leave employer

For maximum security, a blend of employer and individually purchased disability policies provides income continuity.

Long Term vs Short Term Disability Insurance

Disability policies come in two main structures:

Long-Term Disability

Benefits start after 90-360 days disabled
Provides coverage until retirement age
Replace 60-70% of monthly income

Short-Term Disability

Benefits kick in after 7-30 days out of work
Covers 3 to 12 months of disability
Replaces 50-60% of monthly pay

Long-term is designed to replace income through full retirement in case of permanent disability. Short-term offsets lost wages during initial sickness or injury recovery period. Many advise buying both types for comprehensive coverage.

How Much Disability Income Coverage is Needed?

Assessing how much disability insurance you need depends on:

Income Amount – If sole breadwinner, insure up to 70% of total household income. If dual-income household, insure at least enough to cover your portion.

Debt and Expenses – Factor mortgage/rent, food, utilities and other non-discretionary costs into required monthly replacement income.

Savings Duration – Estimate how long current assets would cover expenses if no income. Insurance needs to start thereafter.

Other Income Sources – Account for sick leave from work, Social Security disability benefits, spousal earnings, or other inbound cash.

Employer Coverage – Individual policy integrates with group plan amounts to reach income goals.

Policy Taxability – Disability benefits are non-taxable up to a percentage of previous earnings.

Using budget models, aim for policies providing adequate cash flow until retirement or return to work accounting for. Also factor in potential for medical inflation increasing costs.

Calculating Coverage Needs

When determining required disability insurance amounts, be thorough accounting for:

Monthly basic expenses – Housing, food, utilities, transportation, minimum loan payments, etc.
Insurable earnings – Your gross monthly income to be covered.
Other income sources – Spousal earnings, employer disability payments, Social Security disability benefit estimates.
Financial obligations – Child support, college tuition, eldercare costs.
Savings duration – How long current assets would cover expenses without income.
Desired income replacement percentage – Typically aim for around 60-70% between policies.

Crunching these numbers yields how much disability coverage to acquire for adequate financial protection.

Adding Cost of Living Adjustment (COLA) Riders

An important disability insurance option to consider is a cost of living adjustment (COLA) rider. This causes your benefit amount to increase by a set percentage, usually around 3% annually, to keep pace with inflation.

Benefits include:

Protects future buying power if disabled long-term
Prevents policy payments losing value to rising costs over decades
Especially useful for younger buyers more vulnerable to higher inflation later

The only downside is added premium cost. But COLA riders provide essential longevity for disability benefits over the long-term.

Own Occupation vs Any Occupation Disability

A key distinction in disability insurance is coverage for your specific occupation vs. a more general income-earning definition of disability:

Own Occupation Disability Coverage

Provides income replacement if injury/sickness stops you from performing your regular professional occupation’s typical duties and activities.
Example: A surgeon unable to perform surgery would qualify despite ability to do other non-surgical work.
More expensive but provides protection for your chosen career.

Any Occupation Disability Coverage

Only pays benefits if completely unable to perform work duties of any occupation given training, education, and experience.
Example: A surgeon able to do administrative work would not qualify.
Much harder to qualify for benefits but more affordable premiums.

For high income careers like doctors, executives or engineers, own-occupation coverage provides essential income continuity if unable to do specialized work. Other professionals may find any occupation sufficient.

Return of Premium (ROP) Disability Riders

Return of premium (ROP) disability insurance riders refund some or all premiums paid if no claim is ever made on the policy:

Types

Full ROP – Refunds all premiums paid if never disabled
Partial ROP – Returns a percentage like 50% of premiums if undisabled

Considerations

Provides return on premium investment if not needed
Makes coverage affordable long-term
Offered for both individual and group policies
Adds cost to base premium which increases over time

ROP riders provide reassurance by defraying some costs if good health continues. Weigh additional premiums against value of money refunded later in life.

Taxability of Disability Insurance Benefits

Disability benefits are not taxed as income if structured appropriately within IRS guidelines:

100% of benefits are tax-free if total combined disability income does not exceed highest income earned previously
Benefits are taxable only on amounts exceeding previous peak earning levels
Premium payments are not tax deductible

Taxes significantly reduce real income value of benefits. Qualifying payments as non-taxable income maximizes coverage power.

Getting Approved for Coverage with Pre-Existing Conditions

Those with pre-existing medical issues face challenges getting individually underwritten disability coverage. Options include:

Group employer plans – Required to offer coverage without pre-ex exclusions in most cases.
Association plans – Membership groups like unions may offer guaranteed coverage options.
Shorter waiting periods – A 30 vs. 90 day waiting period may secure approval despite health history.
Partial benefits – Insurer may cover disability indirectly related to pre-ex condition but not if directly related.
Higher premiums – Insurers will take on more risk for greater compensation.
Reduced benefit period – A 2-year plan can be easier to qualify for than lifetime coverage.

While difficult, several avenues exist to obtain some disability coverage even with health conditions, though premiums are likely higher.

Disability Insurance By Profession

Certain occupations have much higher risks of disability. Statistics by profession:

Professional truck driver – 15% chance of becoming disabled

Construction worker – 10% risk of disability

Nurse – 8% risk of becoming disabled

Physician – 5% risk of disability

Higher earners in specialized fields also have more to lose income-wise if unable to work. White-collar workers in risky hobbies need coverage too. Evaluate your occupational and non-occupational hazards.

Disability Insurance Checklist

When shopping for disability coverage, be sure to:

Insure at least 60% of total household income
Weigh adding COLA rider to keep up with inflation
Assess “own occupation” vs “any occupation” policies
Calculate savings duration without income as a factor
Account for other income like spousal earnings and employer disability payments
Get quotes for both individual and group policies to compare
Have current doctors’ records available to facilitate underwriting
Review taxability to maximize income protected

Getting adequate yet affordable disability protection requires thorough financial analysis. An independent agent can assess needs and coordinate optimal blended coverage.

Long Term Disability Insurance Q&A

Here are some common questions about long term disability insurance:

How much does long term disability insurance cost?

For individual coverage, expect to pay 1-3% of your gross annual income depending on age, occupation, benefits selected, and health. Group plan rates through employers are less expensive.

At what age should you get disability insurance?

The younger the better, as rates rise significantly after age 50. Ideally obtain coverage in your 20s or 30s while still healthy to lock in affordable premiums for life.

Is long term disability taxable?

If structured properly, LTD benefits are not taxable income. This provides substantial tax savings versus taxable income.

How hard is it to claim long term disability insurance?

While claims should not be abused, insurers are required to assess claims in good faith based on policy terms. Using an objective independent physician can ease approval.

Is disability insurance worth the cost?

Statistics show a 25% chance of long term disability making income replacement essential. For a few percent of income, LTD coverage provides peace of mind.

Conclusion

While initially an added expense, properly structured disability insurance allows sleeping easier knowing you can maintain your lifestyle if catastrophe strikes. The right blend of individual and employer coverage protects your income, assets, and family if unable to work. But be sure to calculate needs thoroughly, factoring in potential tax advantages. While hopefully never needed, disability protection brings comfort and financial stability when it matters most.