There are parts of personal finance that people associate with financial planning, like paying down debt, building up savings, and planning for retirement. But there is more that goes into financial planning than that alone. One of the most important parts of financial planning is protection planning. That’s the part that has to do with insurance. It’s not glamorous. It not as fun as investing, planning a vacation, or seeing your student loan balance hit $0. However, what I do as a financial planner is help see the holes in peoples financial situations. A big hole for Gen Y is the lack of disability insurance. According to the Social Security website: “studies show that just over 1 in 4 of today’s 20 year olds will become disabled before reaching age 67.” Yikes!
Um, What’s Disability Insurance?
Disability insurance protects you if you were to become sick or injured and were out of work for an extended period of time. Often times, when we think about insurance, we think about insuring our possessions: our home, our car, our jewelry, etc. but we often overlook insuring our most valuable asset: our ability to work. If you were to become severely sick or injured and couldn’t work for many weeks or many months, how long would you be able to pay your monthly bills?
This type of insurance would be used if you were out of work for several weeks or months due to injury or illness. This is also commonly used is for maternity leave. Policies vary, but there is generally an elimination period of a week to a few weeks before your short-term disability policy kicks in. Many people use accrued vacation days or sick time to bridge the gap until their policy starts. After the elimination period, a percentage of your salary (generally 50-70%) is paid until you recover and can go back to work, until your benefits run out, or until your long-term disability policy begins.
Many employers include this type of insurance as a part of their company benefits package. If you don’t have a short-term disability policy you can purchase your own individual policy through an insurance agent. Individual policies give you many more options in terms of elimination period, benefit period and optional protection plans such as critical illness or hospital confinement. However, buying your own individual policy can be expensive and you may be better off building a robust emergency fund and instead save your money. I recommend consulting with a CERTIFIED FINANCIAL PLANNER™ before you go out and buy a policy on your own. (CFP®s have a fiduciary responsibility to do what is in the best interest of our clients. Check out Let’s Make a Plan to find a financial planner to help analyze your financial situation).
What if you’re seriously injured and out of work for months or even years? What would happen? How would you pay for things? According to the Council for Disability Awareness, “the average duration of long-term disability is 31.2 months” – that’s 2 ½ years! This is when a long-term disability policy can be of significant value. This type of policy has a longer elimination period. It can be anywhere from 30 days to a year. Once your short-term disability benefits expire (generally after 3-6 months) then your long-term disability benefits kick in and pay a percentage of your salary (usually around 40-65%). This lasts until you go back to work or until the number of years stated in your policy. Make sure to check the details of your policy to see how many years your benefits last.
Some employers offer group long-term disability insurance. If your employer is among them, make sure to sign up for it. Often times, you have to elect this benefit and there is an additional cost, but being part of a group policy is WAY less expensive then buying an individual policy. Another thing to consider, especially if you’re a high-income earner, is buying supplemental disability insurance coverage. For example, if you’re a doctor and make $300,000 but your disability insurance policy through work would only cover 60% of your salary, you may want to purchase supplemental coverage that would add another 20% to your benefit amount. FYI: you can’t get disability insurance to cover 100% of your salary because the insurance company wants you to have an incentive to go back to work.
What about Social Security Disability (SSDI)? That will help, right?!?
Good luck with that! No, I’m serious. According to the Social Security Administration website: “no benefits are payable for partial disability or for short-term disability.” This is the definition of disability that the SSA uses:
- “You cannot do work that you did before;
- We decide that you cannot adjust to other work because of your medical condition(s); and
- Your disability has lasted or is expected to last for at least one year or to result in death.”
The government assumes that you have other resources available so they use a very strict definition of disability so that it only applies to a small percentage of people.
What should I look for in a policy?
This brings me a very important point: the difference between an “own-occupation policy” versus an “any occupation policy.” Be sure to check the details of the policy to see which one applies to you. If you own a pure own-occupation policy then the idea is that if you couldn’t perform your current occupation then your disability benefits would be paid. However, companies are becoming stricter about how they define this type of coverage, so read the fine print. By contrast, if you had “any occupation” disability insurance and were a lawyer and now you can’t practice law because of a brain injury, but you could still work in a factory, then you could be denied disability benefits. Watch out for this!
Speaking of reading the fine print: find out if your benefits will be distributed pre-tax or post tax. If you are part of a group plan and you pay your premiums PRE-TAX, then you would receive your benefit PRE-TAX as well. This means: you’d have to pay taxes on the disability benefits paid to you. This is another compelling reason to add a supplemental disability insurance policy.
Where To Start
Start by reading your company benefits package and seeing if your can enroll in a group plan for short-term and long-term disability. Many times people in their 20s and 30s figure that they’re healthy and they choose not to elect disability coverage. In my opinion, this is a huge mistake. A group plan is going to be the most cost effective way to obtain disability insurance coverage. If your company doesn’t offer short-term disability, it is possible to “self-insure” by saving and building up assets that you could access if need be. However, if your company doesn’t provide long-term disability insurance, or if you think you need additional coverage then start by talking to a CFP® who can analyze your insurance needs and then send you to a trusted insurance agent in your area.
Disability insurance has many complicated factors that come into play. Long-term disability insurance can be expensive, but remember that you ability to earn money is probably Gen Y’s most valuable asset. If you have children and if you are the primary income provider for your family, long-term disability insurance becomes even more important. In addition, there are things you can look for to make the policy more affordable, such as a longer elimination period (waiting 6 months to a year) before your benefits begin, or a smaller benefit amount (i.e. 40% of your salary replaced instead of 60%).
- Sign up for your group disability benefits during open enrollment.
- Keep building your emergency savings.
- Work with a CFP® to analyze your total financial situation and determine your insurance needs.
Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a CFP® for advice specific to your financial situation.