Disability Insurance 101
Wouldn’t it be nice if the need for disability insurance was non-existent? Well it is for those who have a financial net worth of twenty million or more. Unfortunately, that group represents less than 1% of US families, leaving the balance of the families somewhat on their own to deal with the issue of financial complications derived from a disabling event to the family bread winner. On the surface, dealing with this issue might seem like a daunting task, but when it is broken down into a few basic categories, it becomes much easier to understand. Once understood, it becomes much easier to assess your personal situation, ultimately leading to the development of a plan that works for your family. Here are the categories:
Many people purchase life insurance to protect and provide for their family in the event of a premature death to the bread winner. In a sense, life insurance replaces your most valuable financial asset, your income. Your ability to earn an income is the foundation providing for the necessities of life including lifestyles, goals and dreams. Disability insurance does the same thing by protecting that same asset, your income.
Here are a few statistics according to the Society of Actuaries:
- People in their working years are more likely to become disabled for ninety days or more than they are of dying.
- Your chance of missing at least 90 days of work due to a disability is just under 1 in 3.
- An illness or accident will keep 1 in 5 workers out of work for at least a year before the age of 65
While these might be surprising statistics to some, an even more surprising statistic relates to the causes of these disabilities. It is widely held that most people think disabilities are caused by accidents, when the reality is that most are caused by illness. Irrespective of the cause of disability, the results of a disability can be devastating to a family’s overall financial wellbeing.
While there are a wide variety of reasons why someone should consider the purchase of disability insurance, the primary reason is indisputable. If your inability to work due to a disability-causing accident or illness will create a financial hardship for your family, you need to consider disability insurance. That’s the easy part. The difficult part is quantifying the financial hardship. This is best accomplished by first defining your financial needs (cash outflow) then matching them against your financial abilities to pay (cash inflow). Sources of these funds include your savings, public disability insurance programs, or disability benefits you receive through your employer. If your financial ability cannot adequately cover your financial needs, you need to consider a private disability insurance plan. Here’s an outline that can help you better visualize your needs and abilities:
- Financial Needs (“cash outflow”)— Family financial needs can be categorized as current ongoing living expenses and the need to set aside funds for retirement purposes. While they are both vitally important in a family’s overall financial plan, the most immediate concern in a disability situation are the current ongoing living expenses. The rationale here is that most disabilities are not permanent and it is therefore assumed that at some point you will return to the work force, regaining your ability to earn income again. Here is a list of some of the more basic ongoing living expenses:
- Food—You should have a good estimate of this monthly expense based on the recent past
- Shelter— mortgage payment, property taxes
- Utilities— You should have a good estimate of this monthly expense based on the recent past
- Insurance— Homeowner’s, auto, life & health
- Credit Card Payments— You should have a good estimate of this monthly expense based on the recent past. It’s important to prioritize this along with any other obligations that may impact your credit score.
- Miscellaneous— This is a catch-all category that might include things such as clothing, entertainment, maintenance, etc.
This will be an easy exercise if you have a previously established family budget. If you don’t have a family budget, you should.
- Financial Abilities (“cash inflow”)—Family financial abilities can cover a wide array of sources, some of which are not likely to be available to most. Here is a list of some of the more common sources of cash inflow:
- Savings— bank accounts, investment accounts, life insurance cash value
- Credit— home equity line of credit (HELOC), 401(k) loan
- Family Assistance— gifts, loans
- Public Disability Programs— California State Disability (partial income replacement), Social Security Disability Insurance (needs to be permanent disability and could take a long period of time before a benefit is approved)
- Individual Disability Insurance Programs— Worker’s Compensation (if disability is work related), group disability insurance programs
Public Disability Insurance Programs:
These are governmental programs available at both the federal and state level, although only a few states actually have statutorily mandated State Disability Insurance programs (California, Hawaii, New Jersey, New York and Rhode Island):
- Social Security Disability Insurance (SSDI)— The US Social Security and Supplemental Security Income disability programs are the largest of several Federal programs that provide assistance to people with disabilities. Both are administered by the Social Security Administration and only individuals who have a disability and meet medical criteria may qualify for benefits under either program. Social Security Disability Insurance pays benefits to you and certain members of your family if you are "insured", meaning that you worked long enough and that you paid Social Security taxes. Supplemental Security Income pays benefits based on financial need.
- State Disability Insurance (SDI)— Some states provide disability benefits to qualified residents. Residents of California have access to California State Disability Insurance (SDI), which is a partial wage-replacement insurance plan for California workers. This program is state-mandated and funded through employee payroll deductions. It provides affordable, short-term benefits to eligible workers and the benefit amount is determined by the resident’s level of income over the previous 12 months.
Individual Disability Insurance:
Whereas SSDI and SDI are considered public programs, Individual Disability Insurance is a private program and generally comes from two sources, through an employer or by purchasing a private policy from an insurance broker.
- Employer Plans— Most individuals have some sort of disability insurance through their employer, in the form of Worker’s Compensation (See “Am I covered by Workman’s Compensation?” in FAQ’s). Sometimes, an additional group policy might be available through the employer, union or other association.
- Private Plans— Private plans are offered by insurance companies and are available to most individuals through insurance brokers. There are two main types of disability insurance: Short-Term Disability Insurance and Long-Term Disability insurance. Within each type, options and choices are many and varied, enabling you to design a plan that satisfies your needs while remaining within your budget (See “Can Disability Insurance plans be designed for very specific needs?” in FAQ’s).
A few often-overlooked features of disability insurance are as follows: the insured will receive the “benefit” free from any income tax, and the proceeds can be used for any purpose. The cost for protection can be a bargain, allowing you to provide adequate coverage for your changing needs without breaking the bank.