Do I Need Disability Insurance?

Are you looking at your open enrollment paperwork, staring at that Long-Term Disability Insurance option…again…and wondering if this is something you need to worry about? Think about this: You crash while bicycling and break both arms. Or you’re doing some yoga arm-balance inversion that is way beyond you and damage some internal whatsits in your arms and wrists. Or even more unpleasantly, you contract a chronic disease that makes it impossible for you to get out of bed some days, let alone to go work. What in the hell are you going to live on? So, do you need to worry about disability insurance? Yes. In last week’s post about Open Enrollment,  I listed disability insurance as one of the few decisions that you really need to focus on.

What Is Disability Insurance?

Just as homeowners insurance gives you money to replace your home if it gets destroyed, and, Just as life insurance replaces your income, for your family’s sake, if you die and can obviously no longer earn your income, and Just as car insurance gives you money to replace your car if you total it:

Disability insurance replaces your income if you become disabled and can no longer earn your income…but still need it.

Disability insurance comes in two flavors:

1. short-term, which replaces your income starting immediately and for the first 3-ish months (depending on your policy), and
2. long-term, which replaces your income starting at some point in the future (usually 3-6 months) after your disability begins, and lasting for a long time, ideally until you’re 65

How Much of Your Income Would It Replace?

Though obviously this differs by employer, most of what I’ve seen in tech companies is either that you have to pay for the coverage yourself (in small companies), or you can choose to pay for more coverage than your employer provides you for free (in big companies). For example, your employer might give you disability insurance coverage that will replace 50% of your income. Then you have the option of paying money to increase that to a 60% or 70% replacement rate. To make the math Very Simple, let’s say your income is $100,000. In the example above, your free insurance coverage would give you $50,000 in annual benefits if you have a long-term disability. If you had chosen to pay more to get a 60% replacement rate, the insurance coverage would give you…wait for it…$60,000 annually.

Do You Need Disability Insurance?

Yup. A lot of people, a surprising number of people become disabled during their working life. So, it’s a common occurrence, with potentially devastating financial consequences. To be specific, I mean long-term disability insurance, not short-term disability insurance. Why not short-term disability? Because short-term disability is a, well, short-term problem with a known duration. If your long-term disability insurance kicks in after, say, 3 months of disability, then you need enough money to cover expenses for 3 months. You recognize that definition? That’s right folks, that’s an Emergency Fund. So, instead of paying premiums for a short-term disability insurance policy, make sure you have enough (safe, accessible) cash to cover expenses for, in this example, 3 months. Long-term disability, however, is potentially a <ahem> long-term problem, and we can’t say how long it’ll last. It might 6 months. It might last the rest of your life. And that’s what makes it potentially financially catastrophic. And that’s exactly the sort of thing we buy insurance for!

How Should You Get Disability Insurance?

Most likely, the easiest and cheapest option is to get it through your employer. Private long-term disability insurance policies—one you would get directly from an insurance company like State Farm or MetLife—can be “prohibitively” expensive. I use quotes because it’s still worthwhile paying for, but realistically, few people are willing to pay the expense, statistics be damned. If you’re really lucky (which, in this case, means working for a big company like Google), your company provides both short-term and long-term disability insurance at no cost to you. Even if you are asked to pay the premium, it’s likely still the best deal. You benefit from being part of a large group of people, and “group” insurance is cheaper than “individual” insurance, because the insurance company is taking on less risk insuring the big group of people than an individual…in  much the same way that investing in a diversified mutual fund is less risky than investing in a single stock! (See how I snuck that in there? Two kinds of advice in one blog post!)

How Much Disability Insurance Do You Need?

The basic calculation you need to do is:

   Your expected household expenses, including savings, after you’re disabled

– Other household income (a spouse’s income? rental income? investment income?)

= Income you’d need from your disability insurance

This insurance site has a reasonable-looking calculator to do this in more detail.

Who Pays the Premium Affects How Much You Need. No Really.

Take note:

• If your company pays the premiums on your disability insurance (if they provide it to you for free), then you’ll have to pay income taxes on any benefits you get from the policy.
• If you pay the premiums, then you don’t owe income taxes on any benefits you get from the policy.

You might see how big a difference this might make.

• If you make $100,000/year, and your employer gives you a 50% replacement rate policy, then you wouldn’t receive $50,000. You’d receive $50,000 minus income taxes. Which could make your take-home, say, $40,000.
• If you make $100,000/year, and you pay the premium on a 50% replacement rate policy, then you’d receive $50,000 straight up.

You’ll need to factor this into the calculation of how much disability insurance coverage you need. Maybe you need to pony up for a higher income-replacement ratio with your own money. Or maybe even buy a supplemental private policy.

All the Other Crap You Need to Understand About Disability Insurance

Disability insurance is not a particularly simple product.  Alas. So, to keep this blog post a reasonable length, I’m going to Give Up and simply link to a page that lists out a bunch of important things you need to understand about your policy.

But remember this if nothing else: You need Disability Insurance.*

*Yes, exceptions exist. Do you want help figuring out how disability insurance fits best into your life? Reach out and schedule a free consultation or send us an email. Sign up for Flow’s weekly-ish blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.