Understanding Disability Income Insurance

We all hear a lot about protecting our financial futures by staying out of debt, having an emergency fund, and saving for retirement. Disability income insurance, or DII for short, is another important form of protection that many people don’t have and haven’t even heard of. The purpose of this kind of insurance is to provide a safety net if you develop a long-term disability that prevents you from working. DII will pay you 60% to 80% of your salary until age 65 if you are unable to work.

How do you know if you need disability insurance? If you aren’t rich, your significant other isn’t rich, and your parents aren’t rich, purchasing this insurance is a good idea. If you don’t have one of these safety nets, then your ability to work is your greatest financial asset and should be protected accordingly. Otherwise, becoming disabled could ruin you financially and add a great deal of stress to an already terrible situation.

What should you expect when you apply for DII? First of all, unlike car insurance, you can’t simply purchase it online and be done with it. You’ll have to work with an agent. Acquiring an agent is easy — just fill out a contact form on any DII website and an agent will contact you. You might want to talk to several agents until you find one you feel comfortable with — you’re going to be making a major purchase, after all, so you want to work with someone honest and well-informed. The agent may also try to sell you other products like life insurance, but I would recommend focusing on these two products separately as each requires a good deal of thought and the company with the best DII policy will not necessarily be the company with the best life insurance policy. Some agents work for a particular company, and some can sell you any company’s policy.

Once you’ve found an agent, the actual application process is less simple. First, you’ll talk to the agent by email or phone, discuss your needs, and get an initial quote. Then the agent will want to meet with you in person to discuss everything. You’ll ask lots of questions during and after the meeting until you understand the details of the plan you’re applying for. Then you’ll fill out some forms with your basic information and document your income by submitting recent pay stubs and a couple years’ worth of income tax returns. You’ll also have to take a medical exam and fill out an extensive and thorough medical history form, which may be done by a medic of the insurance company’s choosing. If all of this seems like overkill, keep in mind that the company might end up paying you a fortune over the years if you get hurt, so to protect their interests, a thorough application process is necessary. Insurance companies like applicants to have a three year employment history and an easily documentable, regular income, but even if this doesn’t describe you, the right agent may be able to find a policy that fits your situation.

If you work for a company that gives you DII, you’ve got it easy. You don’t have to find a company, choose an agent, fill out any paperwork or take any medical exams. However, you may want to examine your company-sponsored policy to see if it gives you as much coverage as you’ll need. Company policies may only replace 60% of your income and, what’s more, if you need to use the policy, the income you receive will be taxable (whereas a policy that you purchase yourself will provide tax-free benefits). For this reason, many people choose to purchase additional insurance on their own.

A good DII policy has several important components. It should be guaranteed renewable and non-cancelable until age 65. This means that even if your health degrades, you’ll still be insured as long as you keep paying your premiums. You won’t have to ever take another exam again unless you want to reapply for a new policy (if your income increases dramatically, for example, or you want to switch companies), and your premium rates will be locked in at the time of purchase. You’ll want to make sure you’re getting own occupation (that is, the line of work in which you’re presently employed) insurance to the extent that you can, which will depend on your profession. If you have a typical office job, the policy may offer you own occupation coverage for five years and then after that expect you to get whatever gainful employment you can. However, if your new gainful employment only pays you $7 an hour and your old job paid $25 an hour, your policy will still make up the difference so that you’re bringing home the same amount of money you were during the first five years of your disability (which will be somewhere from 60% to 80% of that $25 an hour).

Disability income insurance is expensive (1% to 4% of your annual pretax salary). If you can’t afford much, get a cheap policy with a good company — it’s better than nothing, and you can always reapply for a better policy later. If you can afford more, make sure you don’t spend more than you really need to. It’s easy to let fear make decisions for you when dealing with a product like this — bouncing the details of the plan you’re thinking about purchasing off of a couple of other people can help you get a sense of whether you’re making the most rational decision.

One way to decrease your premiums is to increase the waiting period before you start receiving benefits. Your agent will probably try to sell you a policy that kicks in on the 91st day after you become disabled. If you don’t have much in the way of savings, don’t have anyone who can help you in a financial emergency, and have a hard time accumulating an emergency fund, this policy is probably a good idea for you. However, you’ll pay an extra couple hundred dollars a year for this benefit. If you have somewhat of a safety net in the way of a well-padded emergency fund, an income-earning spouse or significant other who can support you financially if needed, or family who are willing to help you out in a pinch, you should consider a policy that doesn’t kick in until the 181st day (6 months) or longer. The maximum waiting period offered by most DII companies is two years.

As with all insurance, you’ll have several different payment schedule options. If you pay an entire year’s premium at once, you’ll save a few bucks, and if you pay smaller amounts on a shorter schedule, you’ll pay a bit more. If the fee for breaking up your payments makes a difference between you being able to comfortably pay for the policy and forgoing it altogether, don’t let the additional charge trouble you — it could be as little as $20 extra for the whole year, which is worth it for the peace of mind of not having to fork over $1000 or more all at once. In addition to the payment schedule, some companies (Northwestern Mutual is one) will offer you a choice between a level payment plan (where you pay the same premium every year) and a plan that starts out cheap and increases over time. The idea behind the latter plan is that your income will theoretically increase over time, so you’ll always be spending about the same percentage of your income on disability insurance. The drawback is that over time, this type of plan is much more expensive (like $25,o00 more expensive). Once you choose one option or the other, you can’t switch. You can, however, reapply for insurance later if you’re still healthy and change to the plan that is a better value in the long run.

Here’s a list of well-known companies that offer disability income insurance:

  • Northwestern Mutual (nmfn.com)
  • Guardian (guardianlife.com)
  • MassMutual (massmutual.com)
  • MetLife (metlife.com)
  • Unum Provident (unumprovident.com)

When purchasing a product like this, it’s smart to pick a large, established company that will still be in existence and financially solvent when you need to make a claim. You can always check an insurance company’s ratings through A.M. Best.

Why do you need DII if Social Security provides disability benefits? Social Security really only covers absolute worst-case scenarios. If you can do any job at all, they will expect you to work. Also, Social Security’s benefits, while a nice thing to have, probably won’t be enough for you to live on, especially if you live in an expensive part of the country — Social Security doesn’t take into account the cost of living in your geographic location. Below, I’ve summarized the most important points of the SSA’s program and provided links to their webpages so you can read the information firsthand or get more details if you’re interested.

How the SSA defines disability: “We consider you disabled under Social Security rules if you cannot do work that you did before and we decide that you cannot adjust to other work because of your medical condition(s). Your disability must also last or be expected to last for at least one year or to result in death.” Depending on the coverage you are eligible for, you will either start receiving disability insurance payments in month two or month six of your disability, so even in a worst-case scenario, you’ll have to support yourself for a while before you get any help from social security. Even if you have private disability insurance, you likely will have purchased a policy that kicks in after, say, six months in order to reduce your premiums. Your emergency fund will support you in the meantime.

How the SSA decides if you are disabled: In 2007, if you make over $900 a month, you won’t qualify for disability benefits. Your condition also must be severe enough to “interfere with basic work-related activities.”

List of Impairments: If you have any of these conditions, you are automatically eligible. If you have a condition not listed, the evidence must show that the impairment has lasted or is expected to last for a continuous period of at least 12 months.” Children can be considered disabled, too.

How to prove to the SSA that you are disabled: In a nutshell, you need medical proof, such as reports from doctors who have treated or evaluated you.

You also have to pay into the program (via your social security taxes) for a certain number of years before you qualify.

Your state may also provide disability benefits, but these will only cover you in the short-term, and again, the payments won’t be very high. Also, whenever you’re dealing with a government agency, things tend to be time consuming and complicated, and your claim may not be approved.

Applying for disability insurance can be a bit time consuming and complicated, but if you ever get so sick or so seriously injured that you are unable to work for several months or longer, you’ll be extremely glad that you took the time to protect yourself in this way.

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6 Responses to Understanding Disability Income Insurance

  1. Gail says:

    I notice you didn’t mention Short Term disability through your employer. I paid for this while I was working (it was optional) and boy am I glad I did! I became disabled and it kicked in for the first six months. Because there was no taxes deducted, etc. I basically was getting more ‘take-home’ pay than when I was working. And when you are in the midst of falling into a bad chronic illness, expenses pile up with trips and co-pays to doctors, hospital parking, etc. SSD can be hard to get and has a waiting period also, although if you think you are eligible apply ASAP as the process can be long and arduous.

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  4. Amy Fontinelle says:

    Personally, I don’t think that short term disability insurance is necessary if you have health insurance and a solid emergency fund. I am sure that there are some situations (like yours) where it can be helpful, though.

  5. Gail says:

    Well, You would need an extremely healthy ermergency fund to overcome a short-term disability without short-term disability. I believe 6 years ago my policy ran me about $29 a month. When I had to tap the policy, I received $1600 a month (non-taxable) which covered the mortgage, utilities, food, car payment, etc. If we had used an emergency account, that would have been close to $10,000 gone. Unfortunately since I didn’t have a long term policy it was a very tight time until I was approved for Social Security disability. Many disabilities only last for 6 months or less such as broken legs, etc. and a person would never even be eligible for LTD during that period. My company paid for my insurance for that initial 6 months (I doubt if all do), but then I went into COBRA at close to $400 a month not counting co-pays.

    Talking about a good medical insurance policy and a healthy emergency fund is pie in the sky for many people who are struggling to get by. I think having both is great, but having a STD policy is also a welcome and neccesary addition to help keep your family stable during what can be an extremely rough time and help avoid the financial ruin you spoke of in your article. Incidently the Short term policy doesn’t take long at al to kick in, at least mine didn’t.

  6. Melanie says:

    I have short term diability through my employer.I was in a auto accident over 1 year ago. The driver that was found at fault and ticketed his company has just setteled prior to my getting approval for spinal surgery , injuries caused from the car accident. His insurance was not enough to cover all the expenses.I filed for short term disability due to having spinal surgery. I recieved a letter stating that I qualify, however they state that since I am recieving money from my auto ins. the shortterm money they will pay will be 25.00 a week. I have recieved no money from my auto insurance,we are still in litigation. Help!

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