My biggest fear, particularly from a financial standpoint, is not death.
Being unable to work, yet still having bills to pay, is my personal nightmare.
This is why I am a big believer in disability insurance.
Why Disability Insurance
Did you know that you are three times more likely to become disabled than you are to die before age 65? Think of all the ways that you can become disabled: on the job injury, car accident, diving accident, illness.
In recent years, my personal circle of friends and acquaintances have had some pretty traumatic experiences: a single-car accident that left the driver in ICU and then in-patient rehab for months (fortunately, he’s all better); a horse bucked and threw a friend off, breaking his pelvis (all better now); in two separate diving accidents, people broke their necks and remain paralyzed and out-of-work.
And these are just the big headline grabbing types of disability causes. For many professionals, you may also have something like back issues or chronic illness. Cancer may also very likely put you out of work, for at least awhile. The average duration for long-term disability claims is 34.6 MONTHS. You are looking at about three years of being out of work.
While the first priority is always your health, you’ll do a lot better if you know you are not at risk of losing your house. The stress of recovering is bad enough. Don’t add to it because of financial stress.
Don’t Count on Social Security Disability
The US government has a federal program to help those that are disabled. Social Security has a component that is designed specifically for disabled persons. However, Social Security has tough eligibility requirements that may take years to prove. And once you do prove to be eligible, the benefit will be quite small. It’s likely that the payout from Social Security disability won’t be suitable to keep you in your house.
What Does Disability Insurance Cover?
Health insurance pays medical providers to cover the costs of medical treatment. Disability insurance, on the other hand, pays you cash. This is your income replacement insurance for when you can’t work.
Disability insurance policies typically have a 3-6 month waiting period before they kick in. You can cover this shorter period with a short-term disability policy, such as one through AFLAC. Or you can self-insure this period with a suitable emergency fund.
Most policies will stop paying once you reach age 65, which they consider a standard retirement age. You’ll also be eligible for Social Security retirement benefits at 65 with currently only a 13.3% monthly reduction compared to starting at 67. You’ll also be eligible for Medicare to replace existing health care insurance which may be a large component of your monthly spend.
How Much Do I Need?
If you are buying an individual policy or pay for it with after-tax dollars, most people look to replace 60% of their gross pay. As a back-of-the-envelope calculation, you can use 40% to estimate their total tax liability for state and federal taxes, including the FICA withholdings. Remember, if you are not working, you won’t have to pay these taxes. However, if your company pays for the disability insurance, the proceeds are taxable.
Don’t forget to include bonuses, commissions, or other sources of employment income. Although these amounts may be irregular, many people count on these for their basic budgets and large purchases like cars. If you have a long-term disability, you may have to look into home renovations or a new handicap-accessible van for transportation. So don’t forget to include the irregular income into your calculations, even if you don’t think you’d be buying a new car.
If you can’t afford or don’t want to pay for disability insurance at your salary levels, you can do an evaluation to see what the minimum amount of coverage you need is. I would recommend, at a minimum, enough disability insurance to cover the average month’s expenses, including rent/mortgage, utilities, car, student loan or other debt payments, and food. And don’t look to a bare minimum budget either. If you are disabled, you may end up with more time on your hands and limited opportunities to do other stuff. You’ll want that Netflix and cable packages. Don’t forget about your internet package either!
Many insurers won’t issue policies for more than 60% of your annual income, as a means of incentivizing you to get better and return to work. Another reason to look at prioritizing debt payoff plans.
Eventually, You May Not Need Insurance
As the years go by, hopefully your financial picture continues to improve. Many of us have goals of passive income suitable to sustain our lives. Others build large emergency funds and nest-eggs.
Paid off mortgages and other debt mean you require a lot less to survive on month-to-month. If you have no debt, substantial savings, or substantial passive income, you may decide to self-insure and forego formal disability insurance.
As you get closer to 65 years old, look into whether the cost of the premiums is worth any payout you may receive. Remember, most policies stop paying out at 65.