Disability Insurance

Though you might think it highly unlikely that you will ever become disabled, either on the job or outside of work, you are mistaken. According to the Health Insurance Association of American, at age 40, for example, you have a 19 percent probability of suffering at least one disability lasting more than 90 days.
If you miss work for a short time, your employer will probably provide short term sick leave. You might also collect benefits from workers’ compensation if you were injured on the job. Other government programs, such as veterans benefits, civil service disability, black lung insurance for miners, and Medicaid for low income people, might also kick in. If you were injured in a car accident, your auto insurance will pay you a certain amount of cash for a limited period of time. And if you are a union member, you might be eligible for group union disability coverage.

You will qualify for Social Security disability benefits if you become severely disabled. How much you receive depends on your salary and the number of years you have been covered by Social Security. Following are the ground rules for receiving Social Security disability payments:

  • You must be disabled for at least five months and expect to be out of commission for at least a year, total. Expect the Social Security Administration to take at least three months to process your claim, so file as soon as you think you will be eligible.
  • The amount you receive from Social Security will be reduced by other payments you get from other government disability programs. For example, any money you receive from military, civil service or government pensions, or from workers’ compensation is subtracted from your Social Security benefit. All of these income sources combined cannot exceed 80 percent of your average earnings before you became disabled.
  • You must not be able to perform any job whatsoever, not just the work you did before you were injured.
  • You qualify for Medicare after receiving Social Security payments for two years. You must enroll and pay the monthly premium to receive both medical and hospital coverage under Medicare.
  • You must pay federal income tax on your disability benefits if your income exceeds a certain limit. The most recent limit for adjustable gross income (AGI) plus nontaxable interest income and half of all Social Security benefits is $34,000 for a single person and $44,000 for a couple filing jointly.

Even if you collect from several government programs, you probably will not receive enough money to live comfortably. This is where individual long-term disability insurance becomes crucial. If you qualify, you can receive between 50 percent and 80 percent of your regular salary, depending on the policy, plus cost-of-living adjustments in some policies. Companies do not pay 100 percent of your salary because they want you to have an incentive to go back to work.
Many clauses in disability contracts can be crucial in determining the benefits you receive if you are injured.

Definition of disability. Some policies pay if you are unable to perform your customary job. Others stipulate that you must be unable to do any job before they consider you disabled. Many use a combination of the inability to perform your own job for an initial period (usually the first year of your disability) and then the inability to perform at any job for which you are suited based on your education and experience. Some policies require that you be totally disabled; others pay if you are only partly disabled.

Cause of disability. Some policies provide benefits only if you are injured in an accident. Others pay if you become injured and ill. The best policies cover both accidents and illness, and they pay no matter how you become disabled.

Exclusions. Insurers usually will not pay disability benefits if an injury is caused by a suicide attempt, drug abuse, a crash of a noncommercial aircraft, military service, or a normal pregnancy.

Residual benefits. Residual benefits are partial benefits. For example, if you are healthy enough to work one day a week or earn 20 percent of your former income by performing less demanding tasks, a policy offering residual benefits will pay you 80 percent of the full benefit. The more you work, the less residual funds you receive.

Payment amount. Your monthly benefit is based on your level of income before you become disabled. You can expect anywhere from 50 percent to 80 percent of your predisability income from all sources combined. Higher paid workers tend to receive a smaller percentage of their former pay than do lower paid workers. If you pay your own premiums on a disability insurance policy, they will cost less if you accept a smaller percentage of your predisability pay. You can also add a cost-of-living-adjustment clause to your policy for an extra premium. This clause would raise your disability payments based on an index tied to the yearly change in the Consumer Price Index (CPI).

Benefit payment method. Some policies call for weekly checks, but most pay monthly. A policy also might include a provision allowing the insurance company to pay the entire benefit in one lump sum, cutting short any further liability.

Beginning payment date. Some policies begin paying benefits within a month of your disability; others wait six months or even a year. The longer you can go without receiving insurance benefits, the lower your premiums will be. Before you choose a longer waiting period, however, make sure you have enough savings and other resources to cover your expenses over that time.

Payment caps. All policies limit the monthly amount of disability benefits paid to recipients. It could be as much as $2,000 or $3,000 or far less, depending on the policy. Try to estimate realistically how much income you would need if you were disabled.

Ending payment date. Disability insurance is designed to replace earned income, so benefits may last from one year to the rest of your life, depending on when you get injured and what other sources of income are available to you. If you agree to receive benefits for a shorter time, your premiums will be lower. Most people buy policies that pay benefits until age 65 when they qualify for various government programs.

Renewability. The last thing you want to happen if you are disabled is for your insurance company to cancel your policy. Make sure that the coverage you buy is guaranteed noncancelable, which means that it is renewable at the original premium price. If your insurance carrier does not offer a noncancellable policy, it may offer a guaranteed renewable policy instead, which guarantees that your policy will be renewed no matter what your health condition, though the premium may change.
If you become disabled and you have paid the premiums for disability insurance, any benefits you receive are free of federal, state, and local income taxes. However, if your employer has paid some or all of the premiums, your benefits are partially or totally taxable. Though prices vary widely among disability policies, expect to pay about $1,000 a year for $12,000 worth of annual disability income coverage. While several kinds of insurance companies offer disability coverage, life insurers specialize in the product and will offer the best options at the lowest prices. You most likely will obtain a much better price and more generous benefits if you buy through a group plan. However, if you cannot purchase coverage through your employer, union, or trade association, it often makes sense to purchase a supplemental individual policy.

A specialized type of disability insurance is tied to your ability to repay loans. Banks, finance companies, car dealerships, and other lenders sell credit disability insurance, which covers your loan payments if you become disabled. Mortgage lenders push mortgage disability insurance, which makes your home payments if you have an accident. In general, both credit and mortgage disability insurance policies are not good investments because they are overpriced. You are better served by more comprehensive forms of disability coverage.

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