How Does Disability Insurance Work?

What is it? Why do I need it? Who buys that? How do I get a policy?

What is Disability Insurance?

Income-protection insurance (disability insurance) provides replacement income from a covered claim, if you’re unable to perform at work for a period of time. Disability insurance provides benefits from injuries or sicknesses that are non-work related. Policies will replace anywhere from 60%-70% of your annual income and benefits can be received income tax-free.

Before benefits are paid-out the insured must satisfy the waiting period and/or deductible of the policy, which is typically anywhere from 30-180 days. Premiums will remain level throughout the life of the policy and end once the insured begins receiving benefits. Premium payments begin again once they no longer satisfy the definition of disability within the policy.

Types of Disability Insurance

There are two different types of income protection policies that can be purchased. Both accomplish the same thing, but also, have their differences. Here is breakdown of both:

Short Term Disability

Policies will provide tax-free* benefits for a defined period of time after becoming disabled. Benefit periods are anywhere from 3 to 6 months. Employers usually offer this as a part of their benefit packages. There is typically no underwriting requirement and most employees are able to attain coverage for a low cost.

Long Term Disability

Long term disability offers benefit periods from 2 years up until the age of retirement, which is typically age 65 or 67. Employers can offer this as a part of their benefits package, but most long term disability policies are purchased by individuals. The insured pays the premiums using after tax dollars, which allows them to receive all benefits from a covered claim income tax-free*.

Own Occupation vs. Any Occupation

Each policy will allow you to choose whether benefits will be paid for not being able to perform your current occupation or if you’re not able to perform any occupation after a claim has been filed. It is crucial when purchasing an income protection policy to review the exclusions and limitations of the policy to see, if it is an Own Occupation or Any Occupation type policy. Here is a definition of both:

Own Occupation

Policies will pay benefits when the insured becomes totally disabled and is unable to perform the specific duties related to the current job for which the policy was underwritten for. Even if the person returns to work in another occupation, the insurer will still pay the full disability income benefit as long as the insured can no longer perform the duties of the former regular occupation. Partial benefits will be paid, if you’re able to go back to work in that same role, but unable to perform full-time.

Any Occupation

The definition of “total disability” for an any occupation policy is defined as a condition that prevents a person from performing the duties of any occupation for which that person is reasonably suited by education, training, and experience. Meaning, if you can be a Walmart greeter then benefits will not be paid. Again, if you’re able to return to work part-time then partial benefits will be paid. Reductions in salary after returning to work can be protected by adding endorsements on the policy when it is written.

Who Needs Disability Insurance?

The likelihood of someone being disabled for a period of longer than six months is 1 out of 4 people. If you make an income of significant value to you or your family then you may want to consider purchasing a disability policy. Most families at best will have a three to six month emergency fund for hard times. Income protection insurance is not to make you rich, its to put food on the table and to pay bills. It allows you to remain living the same lifestyle as you did when you were healthy and working.

There are many types of professions where a disability policy makes financial sense to have in place. If you have a unique skill or have specialized in a certain profession then an income protection policy can offer peace of mind when the unexpected happens. Here are a few examples of the different professionals that purchase disability policies:

  • Surgeons
  • Chiropractors
  • Dentists
  • Attorneys
  • Accountants
  • CEO’s
  • Professional Athletes
  • Musicians
  • Nurses
  • Business Owners
  • Key Employees
  • Farmers & Ranchers
  • High Profile Coaches

How Do I Get a Policy?

There are multiple carriers that offer plans and policies can be customized to fit your exact needs. Most policies offer similar benefits, but do vary in premium and benefit outlay. It is best to use a broker when shopping for a plan since they will be able to find you the most competitive option available in the marketplace.

Disability insurance can be the difference between you achieving your dreams or falling short. Everyone wants to grow their investment portfolio and retirement accounts. But, what happens when you can no longer contribute to those because of a life changing accident. Protect your income, because without it you cannot fulfill your life goals or do any of the other things on your bucket list.

*Premiums paid by your employer will be taxed as ordinary income when benefits are received up to the amount paid. Any premiums paid by the employee will be received tax-free as long as after-tax dollars were used to pay the premium.

Published by Michael A. Luna, CIC

Asset protection specialist helping families and business owners achieve their goals.

Leave a Reply

%d bloggers like this: