Over the last few months, I’ve gone down the rabbithole looking into disability insurance. I have adequate coverage with a pretty decent group policy but disability insurance is sufficiently important that I wanted to make sure I wasn’t making any mistakes.
Additionally, I’ve already had multiple readers contact me about disability insurance. That’s not surprising. Disability insurance is much more complicated than any other type of insurance policy you’ll purchase. There’s a lot we’re going to need to sort through.
Since I’m not a disability insurance agent, I reached out to several professionals in the business to speak to them about the intricacies of disability insurance. You’ll see their names and links to their sites throughout this series. We have no financial relationship.
So, let’s get started with the basics of disability insurance.
Do You Need Disability Insurance?
A majority of Americans do not have a private, long-term disability insurance policy that would replace a portion of their income should they become sick or injured. For that reason, disability insurance isn’t something that gets a lot of press.
The reason that people don’t have private insurance is because many people have disability insurance through their employer. I assume most people have given their employer’s disability insurance very little thought (I know I hadn’t up until a couple of years ago). Or, if you have looked at private disability insurance, you’ve realized that it’s incredibly expensive and decided to reconsider it later or put those dollars to work elsewhere.
Sensing concern that people were underinsured (and perhaps that they weren’t selling enough policies), the insurance industry has put together various studies to get your attention. Most show the likelihood of an American becoming disabled during his or her lifetime.
How likely are you get to become disabled?
Well, it turns out the numbers aren’t so clear. Ron Lieber has an amusing piece in the New York Times were he complains that the chance of becoming disabled range from 80% to 30%.
Those numbers sound scary and I’m sure are in part an attempt to drive you to purchase insurance. But at their core they are misleading because they don’t take into consideration your profession. Obviously, the chances of a lawyer becoming disabled due to a back disorder (the second most common disability) are much lower than someone who works for a moving company. However, cancer doesn’t care what you do for a living.
According to Unum, the top reasons for long term disability leave are:
- 16% Cancer
- 14% Back disorders
- 11% Injury
- 9% Cardiovascular
- 9% Joint disorders
But the key takeaway from these studies are that you are far more likely to become disabled during your life than to die prematurely.Yet, if you’re like most people, you’ve probably given way more thought to what would happen if you were to die unexpectedly than to what would happen if you become disabled.
For me, that was in part because I didn’t really connect the dots between something like getting cancer and “being disabled”.
Isn’t cancer why you have health insurance?
But health insurance only covers the medical costs associated with treating your illness.
Health insurance has nothing to do with replacing your income while you obviously won’t be working. That’s where disability insurance comes in.
So being “disabled” is a wide range of circumstances, which includes getting sick and being unable to work. Having reframed it that way, it seems a little more important to understand what would happen should you ever find yourself in that situation..
If you don’t have any disability insurance, you either should consider whether it makes sense to purchase it or figure out a plan should you become disabled. The average Social Security disability benefit in 2016 is only $1,166 per month, which hardly seems enough to replace a lawyer’s lost income.
Three Pillars of Insurance (Health, Life and Disability)
So, how does disability insurance fit into the three pillars of life, disability and health insurance?
Life insurance provides provides a meaningful amount of money to your heirs to replace your income should you die.
Health insurance provides protection from catastrophic health costs that you could incur should health problems arise.
Disability insurance provides protection to cover your income should you become disabled, whether due to sickness or injury.
In this way, I see life insurance as an all-in-one policy. If you die, you won’t have any health expenses, nor will you have ongoing life expenses. Your only concern is making sure everyone else is taken care of.
But if you get sick or injured, you have two problems to deal with: (1) covering the cost of healthcare and (2) replacing your income during the period of your disability. Without protection for both, a disability or illness could be a big problem.
The Basic Terms of Disability Insurance
There’s a few things that make disability insurance unique in the world of insurance. You should understanding these basic parameters:
- Disability Insurance is Proportional to Your Income. Unlike life insurance, the benefit provided by a disability insurance will be proportional to your income. You might have a policy that pays 66% of your monthly income should you become disabled. It may have a cap on the total monthly benefit. You’ll need to dig into your policy to make sure you have enough income from disability insurance to replace your current income should you have a period of disability.
- Tax Treatment of Disability Insurance Benefits. There’s an inverse relationship between the type of dollars you use to pay for disability insurance premiums and the benefit you receive. If you use pre-tax dollars to pay for disability insurance, your benefits will be subject to income tax. Conversely, if you use post-tax dollars to pay for disability insurance, your benefits will be tax-free. If you get disability insurance through a group plan at work, it’s likely being funded with pre-tax dollars (so your benefits will be taxed).
- Disability Insurance is Expensive. Disability insurance costs more because it has a higher likelihood of being used. If you’re purchasing your own private policy, you might spend 1-3% of your current income in annual premiums. If you’re making $200,000 each year, a policy that pays $10,000 each month (60% of your salary) might cost $2,000 – $6,000 a year. Understandably, this makes it a big ticket item that needs some thought.
- You Need Disability Insurance When You’re Young. The worst time for a lawyer to become disabled would be three months after graduating law school. Our hypothetical young lawyer just took on $200,000 in student loan debt and hasn’t worked a day in his life, so probably has a negative net worth. Ironically, a young lawyer is one that is least likely to be able to afford disability insurance and has the most use for those dollars elsewhere. But as you get older and build assets, disability insurance (like life insurance) becomes one of those insurance policies that you can eventually let lapse. Once you’re financially independent, most people drop disability insurance coverage because your assets are producing enough income for you to live on.
- Disability is Subjective. Without getting metaphysical, you’re either dead or alive. That’s not the case with disability. There are 50 shades of gray between healthy and disabled. The definition of disability in your policy is important. Unfortunately, the industry doesn’t use a standard definition of disability so no two policies will look the same. You can’t treat disability insurance as a commodity where you pick and choose the best price. You’ll need to understand most of the policy and the definition of “disability” is probably the most important part.
The series will be spread out over a few months (nobody wants to read about disability all at once). When I’m done, I’ll put together a mini guide that includes all the information and link to it here.
Let’s talk about it. Join us over at Lawyer Slack to discuss disability insurance. We conducted a recent poll and about 55% had disability insurance while another 45% did not. Do you have adequate disability insurance? Let us know in the comments.
Joshua Holt A practicing private equity M&A lawyer and the creator of Biglaw Investor, Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Personal Capital keeping track of his money and is always looking for honest companies that provide insurance for a fair price without selling you products you don't need.