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How Much Disability Insurance Coverage
Do You Need?
More and more workers recognize the need for disability
insurance, also known as income-replacement insurance. The
reason: they are more likely to be disabled for at least 90
days before age 65 than they are to die. But many of those
same workers remain underinsured, and they often don’t
realize it.
One of the major reasons workers are underinsured is that
they assume that their group disability policy at work, perhaps
combined with Social Security disability benefits, will replace
their full monthly income. It won’t, and the gap is often
significant. How much disability coverage do you need?
First, understand that disability insurance—whatever
the source—won’t replace all of your pre-tax income.
At a maximum, your total insurance sources won’t replace
more than 70 to 80 percent. As we’ll see later, that’s
not necessarily a concern, but it is something to be aware
of.
Now let’s imagine the unimaginable: tomorrow you are
disabled and unable to earn any wage income for months, perhaps
a year or more, perhaps permanently. Would you have sufficient
non-insurance sources of income to live on comfortably, keeping
in mind you may have additional expenses associated with your
disability? Sources might include your spouse’s income,
investment income and savings. Will spending these sources
now jeopardize your retirement and/or children’s college
plans?
If the disability is work-related, you may be eligible for
workman’s compensation or veteran’s insurance. An
auto insurance settlement might pay for disability resulting
from an auto accident. But you can’t count on these sources
alone. Social Security may provide benefits, but qualification
requirements are very strict. Some states, like New York,
also provide short-term disability coverage. However it will
only cover off the job related disability.
For most people disability coverage usually is through work,
but here is where much confusion exists, say CERTIFIED FINANCIAL
PLANNER™ professionals.
Roughly nine in ten employers sponsor long-term disability
insurance, according to a Hewitt Associates survey [Money
April 200]—something that would last you more than a
few months, though not necessarily to age 65. But do you know
what percentage of your income your employer’s policy
would actually replace? Four in ten workers don’t, found
a Consumer Federation of America/American Counsel of Life
Insurances study a couple of years back. [Bus Week, June 4,
2001]
Be aware that over half of employer group plans require
employees to pay the premiums, so if you’re not paying
premiums right now, check to see if the employer is paying
for the policy. It may not.
Typically, group policies pay 60 percent of your pre-tax
income, but there are numerous cautions when considering this
figure. Some policies cap benefits at 50 percent, and most
group policies have a monthly income cap ($5,000, for example),
so higher-paid workers won’t be able to replace anywhere
near 60 or 70 percent of their income. Bonus income usually
is not included, either.
New York State Teachers are even more exposed to income
loss. Generally Tier 3 and 4 members must have at least ten
years service credit and be totally and permanently incapacitated
from all further gainful employment. Even worse is the fact
that benefits are generally 1/3 of your final average salary.
Your benefit may be greater if you have more than 20 years
of service credit.
Social Security disability payments the worker might receive
typically offset dollar-for-dollar payments he or she would
receive through a group policy. So when adding up your potential
replacement income, check to see how the group policy treats
Social Security disability income. Individual policies are
less apt to offset Social Security payments.
Taxes are another critical factor. If you pay the premiums
for the group policy with after-tax dollars, the benefits
are not taxable. The same applies to a policy you buy on your
own. But the payments are taxable if the employer pays the
premiums. Paying taxes on 60 percent replacement income could
significantly reduce what you have left to meet critical expenses.
You may find at this point, perhaps with the help of a financial
planner, that you would have an income shortfall if you became
disabled, so you’ll want to buy a supplemental policy.
You may be able to buy this through your employer. But you
may find the group policy caps monthly income too low for
your needs, so you’ll have to buy an individual policy.
And remember, the total from all of your policies can’t
exceed 70 or 80 percent, so don’t try buying policies
from multiple companies in order to receive 100 percent or
more. It won’t work.
One other consideration when determining the amount of coverage
to buy: A sufficient amount today probably won’t be sufficient
years down the road due to inflation, so consider an inflation
rider.
Securities offered through Cadaret Grant & Co., Inc. Member NASD/SIPC, PPG and CG are separate entities. Securities and/or insurance products not insured by FDIC/NCUA or any government agency. May lose value. Not a deposit of or guaranteed by any bank, credit union or any affiliates. Licensed in AZ, CA, CO, CT, GA, ID, MA, ME, NC, NH, NJ, NY, PA, VA, VT and WY.
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