Updated: May 3, 2013 12:14PM
Originally published: August 1, 2007
There have been so many tragedies in the headlines lately that it’s almost impossible not to close your eyes and think: What if?
While no one knows what’s around the next corner, a bit of advance financial planning could make it easier on those you care about if the unexpected does occur. While your thoughts might immediately turn to the subject of life insurance and estate planning, there’s one other consideration that most people overlook.
It’s the possibility that you’ll be seriously disabled and cannot continue to work.
If you are between the ages of 35 and 65 your chances of being unable to work for 90 days or more because of disabling illness or injury are slightly greater than your chances of dying. The average disability lasts two to four years, but some people are disabled for life. During a period of disability, you may not be able to earn your current income - or any income at all. Yet, few of your expenses will decline, and you may have costly uninsured medical bills. Not to mention that without income, you won’t be able to contribute to your retirement plan.
Put in that perspective, it certainly makes sense to insure your ability to earn an income. Yet this is the most overlooked type of insurance on the market. Unfortunately, it may also be the most expensive insurance, because few carriers compete to offer the product. Blame that on rising claims for disabilities caused by everything from drug abuse to psychological difficulties. These days, insurance companies have become very strict about their definition of disability - and who they will insure. Still, if you don’t have a huge pile of savings set aside, it might be worth investigating whether a disability insurance policy could benefit you.
Don’t make the mistake of assuming that company-paid sick leave will last long enough to cover all your income needs in case of a disability. And workers compensation payments only cover injuries or illness that are proved to be work-related. It’s a time-consuming process to substantiate your claim. Social Security does provide some disability income, but only after an arduous claims process that results in benefits only for the severely disabled. None of these programs comes close to replacing your previous income. Only disability insurance will provide you with a regular monthly check to replace your lost income.
Disability insurance may be offered as part of a group benefit provided by your employer, or purchased independently. Disability insurance costs less when purchased through a company benefits plan, and premiums are usually paid with pre-tax dollars. But if you ever have to receive a monthly disability check from a company plan, you’ll owe income taxes on the payments. Some companies allow payroll deductions on an after-tax basis, so future benefits would be tax-free. If you purchase a disability policy on your own, you can expect to pay more and you won’t receive any tax deduction for the premiums. But any future payouts will be tax-free. And keep in mind that if you leave your company, your disability insurance may not be portable.
The most important consideration in purchasing a disability policy is the actual definition of what constitutes a disability.
Some policies pay benefits if you are unable to perform the duties of your customary occupation; others pay only if you cannot work at any gainful occupation. And some only cover the difference between what you can earn after your disability, and what you were earning before the illness or injury, up to the limits of the policy.
These days, even ``own occupation’’ policies have some limitations, requiring you to work at some occupation after receiving two years of full benefits, if possible. Then your policy will pay ``residual benefits,’’ which reflect the percentage decline in your income as a result of your disability.
The other critical element in purchasing a disability policy is to make sure it is non-cancelable (as long as you keep paying the premiums) and does not require periodic health examinations. Also make sure it has a guaranteed annual premium that cannot be increased. Of course, you’ll have to take a physical exam before the policy is originally issued. If you have pre-existing conditions, they may be excluded as a cause of disability, or you may not be granted coverage at all.
There are several key considerations in pricing a disability policy: The amount of monthly benefits. This amount is typically limited to 60 percent of your current pre-tax income, which you must prove at the time the policy is taken out.
The waiting period. This is the lag time before payments start, usually a minimum of 90 days.
Term of benefits. It’s most common to purchase coverage to age 65, when Social Security will provide ongoing income. You can save money by purchasing coverage for a shorter period.
Cost-of-living adjustments. Many policies either allow you to purchase additional benefits without evidence of insurability, or guarantee a small annual increase in benefits to keep up with inflation.
Very few insurance companies underwrite disability insurance, compared to the many that provide term and universal life insurance.
And disability insurance specialist Brad Gordon of MAF Cos.
(630-834-2210) reports that those that do offer these policies are becoming more strict about their definition of disability, frequently restricting claims for mental, nervous and drug-related disabilities.
Among the larger companies in this field are: Provident, Unum (which is merging with Provident), Northwestern Mutual, Guardian and Principal Financial. For more information and price quotations you can contact those companies directly to speak to their agents, or use the only online service that quotes disability insurance, MasterQuote at www.masterquote.com.
If you’re sure you have plenty of savings to tide you through a period of recuperation from an accident or illness, you can pass this column on to someone else. But if you have large, ongoing expenses and no cash cushion, without disability insurance you’re tempting financial fate.
Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Pennzoil Co. You can send her questions via e-mail at email@example.com. Her second book, published by HarperCollins, is Terry Savage’s New Money Strategies for the ‘90s. Copyright Terry Savage Productions.