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Understand the Key Areas of Disability Insurance

Disability insurance: Disability insurance provides payments to insured individuals in the event that regular income is interrupted by illness or an accident. Disability is similar to life insurance, but is really “earning-power” insurance. An advantage of disability insurance is that it may provide you with between 67 and 80 percent of your after-tax income if you are disabled by a long-term illness or injury. Anyone who depends on earned income should at lease look into disability coverage.

A disadvantage of this type of insurance is that benefits apply only if the disability is work-related. If the accident happens outside of work, no coverage is provided. You do have the option of purchasing disability insurance to cover illness or accidents that are not work-related, but it is expensive unless it is provided as part of a group plan.

The major sources of disability insurance are employers, the government, and private providers. Some wonder if the state-provided workers’ compensation is sufficient. What about if the accident is not work-related?

Workers’ compensation coverage is determined by individual states, with wide variability between states. Social Security benefits vary depending on your salary, how many years you have paid into the system, and how long the disability is expected to last.

The key question is how much coverage you should have. Generally, you should have enough coverage to maintain your living standard should you no longer be able to work. Your investment income will not stop with a disability, but your income from working will stop. If you have sufficient savings, you may not need much insurance, perhaps only 30 percent of after-tax income, depending on your investment portfolio. If you have little savings, you may need more, perhaps 80 percent.

There are eight key areas of disability insurance:

  1. Definition of disability: What exactly does the policy consider a disability? Stick with a policy that defines disability as an inability to perform your normal job. A combination definition may include “if you can’t perform your normal job for the first two years, and afterwards any occupation for which you are reasonably suited” may be acceptable.  The latter definition will have lower cost.
  2. Residual or part-time payments when returning to work part-time: Some policies offer partial disability payments that allow workers to return to work part-time. These payments make up the difference between part-time and full-time work
  3. Benefit duration: Policies state how long the benefits will continue. Most policies provide benefits for a maximum period or until the disability ends (or the disabled reaches age sixty-five or seventy). Short-term disability policies generally provide benefits from six months to two years, after a wait of eight to twenty days. Only a long-term policy makes much sense. Your emergency fund protects short-term.
  4. Waiting or elimination period: Policies determine the waiting period before the benefits begin. Most policies have waiting periods of between one and six months. Generally the longer the waiting period, the less expensive the policy.
  5. Waiver of premium: The waiver of premium is an option that waives the premium payments if you become disabled.
  6. Noncancelable option: Make sure you have a policy that cannot be cancelled. This protects you and guarantees your policy is renewable.
  7. Rehabilitation coverage: Rehabilitation coverage provides for vocational rehabilitation, allowing the policyholder to be retrained for employment through job-training and employment-related educational programs.
  8. Cost of living rider: This provides for inflation adjustments to protect you from the impact of inflation.

Disability insurance is expensive. Generally, the annual premium will be around 1–2 percent of the income replaced. For example, a policy replacing $50,000 per year of annual salary would cost about $1,000 per year.


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