The need for disability insurance coverage is an often overlooked but necessary one. According to research by the National Fibromyalgia Association, 64 percent of workers say there is a 1-2% chance of long-term disability but the reality is that roughly 25 percent of today’s 20 year olds will become disabled before they retire.
Disability Insurance Basics
When reviewing your existing disability policy or considering a new policy, there are a number of items you will want to be aware of.
Disability Insurance Benefit Amount
The benefit amount is what you will receive should you qualify to receive benefits under your insurance policy. While the appropriate amount will vary based on your situation and that of your business, a general rule of thumb is that 60% of your annual income is a good starting point. As long as the policy was paid for using after tax dollars and not by your business pre-tax the benefit amount will be received tax free.
Own Occupation or Any Occupation
There are two standards of occupation to be aware of on a disability insurance policy.
Any Occupation insurance stops paying or reduces benefits if the insured is able to work any job that is suitable based on education, experience, and age. This means that the insured could be forced to go back to work in a lower-paying job because benefits were reduced or eliminated.
Own Occupation requires that the insured be capable of returning to their line of work and is oftentimes more appropriate for business owners and individuals in highly specialized fields.
The benefit period will typically be for a defined number of years or until a defined age. The risk with a policy that provides benefits for a defined number of years is the potential that additional benefits are still needed to sustain lifestyle after the benefit period ends.
Utilizing a policy that pays until a defined age, paying until age 67 when an individual reaches Social Security full retirement age (FRA), for example, allows for a more seamless transition in most cases from one benefit type to another.
The elimination period on a disability policy is the defined amount of time that an insured must wait until they can start receiving benefits from their policy. They typical elimination period is 60-90 days and a short term disability policy can be appropriate to bridge the gap during this time.
Riders on a disability insurance policy allow an insured to add additional benefits or protect against additional risks. A few common riders that individuals may consider adding to their policy include:
Cost-of-living adjustment will allow the benefit amount to be adjusted to keep up with inflation over time. This protects the insured from the purchasing power of their benefit to erode away if their disability lasts for a significant amount of time.
A guaranteed renewability rider insures that a policy holder can renew their policy at the end of each term up to a specified point regardless of existing health conditions.
A future purchase option allows a policy holder to buy increased covered at a later point without providing additional medical information. This can be valuable for a business owner with a likelihood of higher expected income that they want to be able to insure against.
Disability Insurance Considerations if you are a Business Owner
Income Impact on Disability Insurance Coverage
Many insurers understand that a side effect of the tax code providing favorable opportunities for deductions to business owners means lower reported incomes than may be reality. Because of this, several insurance companies will provide a credit, up to 20%, to their declared income which allows them to qualify for more of a benefit than they otherwise would.
Disability Insurance Consideration if you have a Business Partner
There are additional types of disability policies to consider if your business has partners or key employees that would leave you vulnerable if they were to become disabled.
Disability Buy-Out Insurance
This type of policy is designed to help finance buying out a partner that becomes disabled. It is similar in nature to a buy-sell life insurance policy but designed to protect against disability instead of premature death.
Due to the unique nature of this type of policy, there are restrictions that are not common for a traditional disability insurance policy. The elimination period is generally much longer, oftentimes one to two years and the benefit will be paid as a lump sum or a limited number of annual payouts. This type of policy can be extremely valuable for an ownership group with multiple partners that might find themselves in a situation where they need to buy out a now disabled partner.
Key Employee Disability Insurance
A business that has an individual or small group of individuals that are responsible for driving a large portion of the revenue may benefit by placing a disability policy on these key employees. The loss of these individuals can have high replacement costs and can be disruptive to the operation of the business so the goal of this type of policy is to provide capital to the owner to weather that storm.
Disclosures: The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James.
These policies have exclusions and/or limitations. The cost and availability of disability insurance depend on factors such as age, health, occupation and the type and amount of insurance purchased. As with most financial decisions, there are expenses associated with the purchase of disability insurance. Guarantees are based on the claims paying ability of the insurance company.
Insurance products offered through Raymond James Insurance Group, Inc., an affiliate of Raymond James & Associates, Inc. and Raymond James Financial Services, Inc.
This was written by Michael Dunham, CFP®