Insurance is a necessary expense to protect against unexpected losses. Even if it’s never used, it’s a fundamental part of any comprehensive financial plan. One area often overlooked, is protecting against the loss of income associated with the ability to work. According to a recent Social Security Administration Factsheet, a “sobering fact for 20-year-olds, is that more than 1-in-4 of them becomes disabled before reaching retirement age”. In the unfortunate case you’re one of four, how would you provide financially for yourself and your family? What if you needed a caretaker or additional help? Would you be able to cover the cost without incurring massive debt or wiping out any assets you may have? Disability insurance is designed to protect you from these costs, but does that mean you should buy it? Perhaps, but you need to weigh your options first. The cost, your current financial situation, and your current financial trajectory all need to be considered before purchasing a policy.
The Lowdown on Disability Policies
Most disability policies are structured similarly. The most attractive policies have a 90 day elimination period after you become disabled before they’ll pay any benefits. This is to ensure the disability is long-term or permanent, not just temporary. Generally, the shorter the elimination period the more expensive the policy and vice versa. You pay for the extra insurance that you’ll receive benefits sooner rather than later.
Next, they pay benefits typically as a monthly check defined as a certain percentage of your income (usually between 50-60 percent). Benefits can be paid over 2, 5, or 10 year periods. This may seem like a short amount of time. Believe it or not, however, 5 years will cover most disabilities as the average claim lasts just under 3 years according to the Council for Disability Awareness. Why? Well if you look at the top two leading causes of disability claims from the CDA’s 2013 Long-Term Disability Claims Review, we find that 28.5% of claims were for musculoskeletal/connective tissue disorders followed by 14.6% for cancer. As we know, these conditions typically either end in death rather quickly, or they improve with treatment.
Cost Of Disability Insurance
The average cost for a quality private disability policy is between 1% – 3% of your annual gross income. As an example, if you earn $50k/yr you could pay anywhere from $500-$1500 in annual premiums depending on your age, occupation, level of benefits, and any optional riders that you include on the policy. Many people might be turned away at this cost. If you are already struggling financially, this can make disability insurance unattainable. The good part is, though, that many of us already have easy access to a low-cost disability policy.
Many employers offer disability insurance as part of their benefits packages. Large employers can buy group policies that lower the individual cost of participation. Some employers will even pay 100% of the cost and automatically enroll you upon setting up your other benefits. If you have access to low-cost and/or free coverage through your employer, there’s little reason not to take full advantage of it.
Your Current Financial Situation
Once you’ve determined whether the cost is a limiting factor or not, you should take a look at your current financial situation. Are you the sole breadwinner in your family? Do you pay a mortgage every month? What kind of emergency funds do you have saved? What support would you receive, financial or otherwise, if you were to become disabled? These are just some of the questions you need to answer as you think about the impact a long-term disability could have on your financial health. Even with an emergency fund in place, you still want disability insurance to protect against loss of income in excess of 3-6 months (the recommended emergency fund balance). Same goes for any other assets you may want to protect against withdrawing from such as home equity or 401(k). Disability insurance can provide a high degree of certainty that you won’t end in financial ruin and provide a stopgap in the event you’re unable to earn an income for a period of time.
Your Current Financial Trajectory
As we grow older, get married, have kids, buy a house, and make more money, our financial lives become tremendously more complex. There’s simply more to consider and manage. We never know what life will throw in our direction, whether it be unexpected expenses, a death, or a disability. We can’t decide when or how that will occur, but we can still prepare for it. Deciding how to prepare, however, requires asking yourself where your financial life is currently taking you? Are you on the up and up or are you struggling? If you are making good progress towards your financial goals and have accumulated some assets, you don’t want a disaster to toss you from the upper rungs of the ladder you are climbing. Conversely, if you are struggling, you don’t want to dig yourself an even deeper hole. No matter where you fall, there are steps you can take. Disability insurance is just one of them, but unfortunately, one that is often overlooked. You can’t let the worry, uncertainty, or fear stop you from taking action.