Disability Income - The Foundation of Any Financial Plan
Why You Need Long Term Disability Income Insurance -
Disability income insurance gives you an income to live on if you become disabled and cannot work. If you do not own a disability income policy, you should look into getting one. If you already own a policy, or multiple policies, it is a good idea to review them and make sure that they are covering everything that they need to and that you are not under or over insured.
The Definition of Disability
The most important part of any disability income insurance policy is where it defines what is and what is not a disability. Life insurance is much easier to define than disability insurance—life and death are black and white; disabilities are not.
Disability payouts are an entire niche within law. The payouts come down to how the insurance policy contract is written. The strongest definition states that a person is disabled if they cannot work in their chosen (own) occupation (defined as their specialty). The policy will then pay out its full amount to a certain age, starting after a certain elimination period, and may have a few riders attached to it. “Specialty-specific,” “own occupation:” those are the words you are looking for.
Weaker definitions of disability include “modified own occupation” and “any occupation.” Some people consider these options because of the lower cost. However, the weaker the definition, the more circumstances there are in which one could become disabled but not receive payments from the insurance company. If people are not receiving payouts, then what is the point of having the policy? At BC Brokerage, we look for “own occupation” with all of our clients.
How Much Disability Insurance Do You Need?
Generally, insurance companies will allow you to buy enough insurance to replace 60-70% of your gross income. Since most high-income professionals are putting 15-35% of their income toward taxes, that is usually MORE than enough income to live on. Remember that disability income insurance benefits are completely tax-free, unless your employer pays the premiums. If you already have a sufficient nest egg that would support your desired retirement at age 65, then you may need even less.
Choosing an Elimination Period
Policies will often give you a choice of an elimination period. An elimination period is the length of time between the date of disability and the date when payments begin. Because everyone should strive to have a liquid emergency fund that could cover at least three months (90 days) of expenses, one could live off this money for the first three months in the event of a disability. Having an emergency fund will allow you to choose a 90-day waiting period for your disability insurance policy rather than a more expensive 30-day elimination period or blending in a Short-Term Disability policy as well. There is not much of an additional discount for a 180-day period, and, frankly, saving 6 months' worth of living expenses results in too large an opportunity cost. This money would be better off invested – stick to 3 months of income to stash away in your emergency fund.
Guaranteed Renewal versus Non-Cancelable
You should be aware of a few other insurance terms. A policy can be one of three things: conditionally renewable, guaranteed renewable, or non-cancelable.
• Conditionally Renewable: With these policies, the insurance company can cancel the policy whenever it likes. These are very rare.
• Guaranteed Renewable: The insurance company can raise the rates of everyone who is a certain age, lives in a certain state, or practices a certain specialty, but it cannot cancel the policy if you pay the premiums.
• Non-Cancelable: The insurance company cannot raise rates at all and must renew the policy as long as you pay the premiums.
Obviously, the non-cancelable policy is the best option. However, it is rare for a company to raise rates. Therefore, if the company offers a substantial discount for a policy that is only guaranteed renewable, you should consider taking it and saving some extra money.
Residual Disability Riders
Most good policies include a provision for partial disability. That means if the client can still work part- time, or can still earn some money, then the insurance company will help make up the difference in income. This provision is important if a disability is only temporary. As one gradually recovers from the disability, the residual disability rider will ensure that they get some financial assistance to make up for the lost income. Many times, this rider is already built into the policy at no extra charge. Be aware that the rider with each company is slightly different. Some are better than others, and the better ones usually cost more.
Cost of Living Adjustment (COLA) Rider
All individual policies, and some group policies, will offer a Cost of Living Adjustment (COLA) or inflation rider of some type or variation. Riders are different with each company. Be aware that this rider does not increase the initial disability payment you receive—it will take effect once the benefit is paid.
If the policy you buy in 2018 says it will pay you $8,000 a month if you become disabled, it will pay $8,000 the first month whether you become disabled in 2020 or 2040. But once the policy starts paying, it will gradually adjust upward at the rider percentage that the client purchased (usually 3-5%).
Future Purchase Option Rider
The future purchase option rider allows the client to buy more insurance when their income increases without having to prove they are still insurable (no questions or medical exams). Pricing might change down the road as well.
This is a smart rider to purchase when the company does not allow you to buy as much insurance as you need. For example, most white collar and white coat professionals are limited (by insurance company policy and by their inability to afford it) to buying less benefit than they really want to live on for the rest of their lives. Therefore, for these white collar and white coat professionals, it makes sense to buy a future purchase option rider. But if you’re in your peak earnings years and/or nearing retirement? Just buy the amount you need and save money on the rider.
Catastrophic Disability Rider
Many companies now offer a catastrophic disability rider. This means if one becomes extremely disabled (i.e. cannot do at least two out of the six Activities of Daily Living (ADL) —the long-term care triggers), the company will pay out an extra and larger benefit than the original policy. Sometimes, this rider is included in the policy, meaning you do not have the choice to reject it and save some money. Generally, it is best to use the money the rider would cost to buy a larger disability benefit from the beginning if possible.
Some companies allow you to buy a rider that, if you become disabled, not only pays you a monthly benefit to live on, but also puts some additional money into a separate account for your retirement.
Since the company’s investment options are generally poor compared to what is available on the open market, it is usually best to skip this rider. Of course, you need to make sure that the benefit you have purchased is large enough not only to live on, but also to save for retirement, since the policy will only pay until you are age 65, 67, or 70. These ages are deemed as your “benefit period.”
Unless you are already financially independent, or can live off your spouse’s income in the event of your disability, you need to have disability income insurance. Policies vary, both in features and in price. Shop carefully the first time—put your premiums on auto-pay, and move on to other financial matters.
Want to review your current policy with BC Brokerage? Need a quote for Disability Income insurance? Contact us today, we are here to help.
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