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Disability insurance: Everything you need to know

At a glance:

  • What is disability insurance?

  • Group and individual plans

  • Factors involved in choosing a disability insurance policy

  • Disability benefits

  • Summary of disability insurance

About 26% of American adults are currently living with a disability, according to the Centers for Disease Control and Prevention, and one out of every four individuals in the US workforce will suffer a disabling injury before retirement. In addition, close to two-thirds of Americans disabled as adults are unable to work at all, and about a third are limited in the types of work they can perform.

The chance of a disability occurring is high enough that many people opt for insurance to protect their income in the event of such an unfortunate occurrence. Disability insurance can provide a financial safety net in the event of an injury, disease, or condition that prevents you from working in either the short or long term.

Registered nurse Paige Duracher checks Jacqueline Parker's vitals in the cardiac step-down area of the University of Mississippi Medical Center in Jackson, Mississippi October 4, 2013. Jacqueline Parker is a retired state employee who receives her heath insurance through Medicaid. Mississippi is one of at least 20 states that has decided not to expand Medicaid under the Affordable Care Act, better known as
Registered nurse Paige Duracher checks Jacqueline Parker's vitals in the cardiac step-down area of the University of Mississippi Medical Center in Jackson, Mississippi. (Photo: REUTERS/Jonathan Bachman)

What is disability insurance?

In exchange for you or your employer making premium payments, disability insurance provides you with benefits that make up some of the income you lose when you can't work due to a medical condition.

Some disability insurance policies will pay benefits only if you can't work in your current occupation, but not if you can work in another occupation. Other policies cover a disability for a specific occupation, such as for a surgeon who has carpal tunnel syndrome and can't operate.

How disability insurance works

Disability insurance is designed to replace your income stream from a job during a specific period of time. Typically, the insurance will pay part of your salary — payments generally range from 50 to 70% of your salary — once you've been off work for a legitimate medical disability for a specific amount of time. In most cases, a doctor must certify your disability and the insurance company must approve your claim before benefits are paid. A disability is defined as the inability to perform job functions due to a physical or mental medical condition.

Two types of policies

Policies fall into two categories: short-term and long-term. Short-term disability insurance covers a short-term inability to work due to an illness or accident, generally no longer than a year in duration. Most long-term disability policies kick in after a three- to six-month waiting period or when short-term disability policies terminate. Long-term disability benefits are generally provided for people with severe injuries or illnesses that will keep them unable to work for years, or even for the rest of their lives.

Public disability programs also exist

You're probably aware of public disability programs designed to provide income replacement insurance for the long term. Social Security provides long-term disability payments to people who are seriously disabled and unable to work, while the Veteran's Administration provides disability benefits to military veterans who were disabled in the course of service with one of the armed services. State workers' compensation programs provide disability coverage for workers injured while on the job.

Group and individual plans

Many employers provide short- and long-term disability insurance to their employees. Some provide long-term but not short-term coverage. Either the employer pays the entire premium or part of the premium with the employee picking up the rest. In some cases, employers offer basic coverage and give employees the chance to pay for additional coverage at a group rate. Group rates are discounted rates offered by insurance companies to large groups and employers. Generally, it is much more affordable to participate in employer group rate disability insurance than individual disability insurance.

When the policy kicks in

If you have disability insurance through your employer, the policy will kick in under certain conditions established between your employer and its insurer. For a short-term disability, you usually have to be out of work for at least a day or up to seven days before benefits kick in. If you have them, you can use sick days to fill in this gap before short-term disability benefits are available. While sick day pay is generally at your regular pay rate, short-term disability pay rates are lower and may not come on the same schedule as your paycheck. You may have to check in with your doctor weekly and report back to your employer if your disability continues beyond a week or two.

Individual disability policies

Individual disability policies are those that you purchase directly from an insurer. Insurers will generally require you to pass a physical and disclose any health conditions that may affect your ability to work. Individual disability policies offer a range of benefits and options, including the level of benefits available, the waiting period before benefits are available, and ability to renew the policy. The more generous the benefits and terms, the higher the monthly premium will likely be.

Policy overlap

Short-term and long-term disability policies are usually purchased separately, although benefits should be coordinated so that the policies don't overlap. Most policies cover both on-the-job and off-the-job accidents and illnesses. Insurers generally offer coverage only up to age 65, when Social Security benefits kick in and require you to apply for Social Security disability insurance if your disability is severe enough.

Factors involved in choosing a disability insurance policy

If you're seeking an individual disability insurance policy, there are a number of factors to consider, including:

Short-term versus long-term

To be fully protected in the event of a disability, purchasing both types of coverage is optimal. If that's too expensive, you've got to choose. Most people opt for long-term coverage over short-term.

Coordination of benefits

Before signing up for a policy, check to see what coverage your employer offers. You'll want coverage that complements what you already have, if you do have other coverage. Also, realize that insurance companies won't pay for the same problems multiple times, so if your group policy at work picks up a particular claim, your individual policy won't, and vice versa.

Elimination (or waiting) period

This deals with how long you have to wait before collecting benefits—the shorter the wait, the higher the premium.

Cancellation features

To avoid having your policy cancelled in the future due to any health problems you may experience, choose a non-cancelable policy over one that can be cancelled. These policies are more expensive, but they ensure that you have access to coverage unless you fail to pay the premium. Additionally, the premiums on these "non-can" policies cannot be raised.

Renewability options

When you opt for a guaranteed renewable policy, you ensure that you can renew your policy with the same benefits as long as you continue to pay your premium on time. Again, these policies are more expensive and don't guarantee that there won't be an increase in your premium, but that increase can't be any more than other policyholders in your same classification.

Amount of insurance

You need to choose a benefit amount that can replace from 50 to 70 percent the income you would have received from working. The higher the benefit, the more expensive your premium. Insurance companies typically pay benefits on a weekly or monthly basis, so when choosing a benefit amount, think about your monthly expenses and what items in your budget are absolute necessities—food, mortgage payments, car payments, utilities—and what are optional, such as cable TV, eating out, and gourmet coffee.

Cost of living adjustment

As prices rise over time, the value of your benefit will be eroded. To avoid this problem, you can choose a policy with a COLA (cost of living adjustment).

Waiver of premium

When you're disabled, money is tight, so a nice policy feature to have is one that waives your disability insurance payment after you've been disabled for a certain period of time, such as 90 days.

Additional purchase

Should you decide you need more coverage later on, a policy with an additional purchase option allows you to purchase more coverage without going through an additional physical.

There are factors that determine how expensive individual coverage is for each person. These include your overall health, what type of job you do, and your age and sex. In terms of your health situation, you typically must undergo a physical and a blood test to determine the current state of your health and whether you have chronic medical conditions. Some insurers will refuse to write policies for individuals with illnesses or chronic conditions, while others will write a policy with a higher premium or exclude that specific condition from the individual's policy.

Job and lifestyle factors

In addition, your job and lifestyle will influence the cost of a policy. If you have a job as a construction worker, for example, coverage will be much more expensive than if you sit in an office and work on spreadsheets all day. Certain high-risk hobbies, such as skydiving and mountain climbing, may also affect your rate negatively. Your age can also influence the cost of the policy, as younger workers are generally healthier; you can avoid excessive age-related increases if you choose a policy that is renewable.

Get the ratings

When selecting a policy, consider the issuing company's financial strength. You don't want to buy a policy and then find out that your insurer is going out of business. There are five independent companies that assess the financial strength of insurers, and each uses a different rating system. You can find financial strength information from each rating agency here:

  • A.M. Best Company:, 908.439.2200

  • Fitch Ratings:, 212.908.0500

  • Moody's Investor Services:, 212.553.1653

  • Standard & Poor's Insurance Rating Services:, 877.772.5436

  • Weiss Research:, 877.934.7778

Disability benefits

If your disability benefit payments come from a policy that you purchased, those funds are tax-free. However, if your payments are from an employer-funded policy, they are taxable, meaning you'll have less money to pay your bills.

When you return to work

Policies differ on whether you can return to work part-time and still receive benefits because you haven't returned to work full-time. By selecting a residual or partial disability waiver, you can collect a part-time salary and partial disability benefits; without such a rider, you won't qualify for additional disability benefits should you return to work part-time.

Under a return-to-work disability insurance provision, you will still be able to collect medical benefits for your disability even if you are back at work. Otherwise, your insurer could take the position that your return to work meant that you were fully recovered from your disability and didn't need further benefits.

Summary of disability insurance

When considering insurance needs, don't discount your need for disability insurance. Obtaining coverage either through your employer or an individual policy will enable you to at least cover your most important financial obligations in the event you can't work. Insurance companies offer a number of options, including short-term and long-term coverage with a variety of riders so that you can find a policy best suited for you and your family.

When purchasing insurance on your own, also be sure to assess the insurance company's financial condition to make sure it is financially strong and will continue to do business so that you can realize your benefits should you need them.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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