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Disability Insurance 101
What is the purpose of disability insurance?
Disability insurance helps replace some of the income you’d lose if you became injured or sick to the point that you’re unable to work. At its core, disability insurance is there to pay the bills and put food on the table when you can’t.
Disability insurance takes all shapes and sizes: from short durations to long, small coverage amounts to large, and lenient requirements to strict. We’ll cover all the basics here.
Do I need disability insurance?
To the invincible among us, the chances of experiencing a disabling injury or sickness and missing work feel slim. Unfortunately, the numbers tell a different story. According to the Social Security Administration, more than a quarter of 20-year-olds today will become disabled for a year or longer before they reach retirement.1
Financial experts typically recommend at least some form of disability insurance. Which makes sense, especially considering the widespread lack of emergency funds: 60% of Americans don’t have enough money in their savings to cover an unforeseen $1,000 expense.2 Imagine the thousands of dollars more someone could lose in the wake of a job-ending disability, and you’ll soon understand that many Americans are completely unprepared.
What are the different types of disability insurance?
Although disability insurance frequently varies in how it’s structured, you’ll usually see policies fall into one of the following categories:
- Short-term disability (STD) insurance is a category of policies that provide benefits for different lengths up to two years maximum, such as six months or one year. STD insurance is a common employer-provided benefit.
- Long-term disability (LTD) insurance is a category of policies that provide benefits for two years or longer—sometimes up to age 65 or the rest of the insured’s life. Sometimes LTD coverage is offered by employers, but short-term disability is more common.
- Social Security disability insurance (SSDI) is the government version of disability insurance. Qualifying for Social Security disability insurance is more difficult than meeting the requirements of a private disability insurance policy because the government’s definition of “disability” is much stricter. We won’t get into the details here, but if you’d like to learn more about SSDI and whether you might qualify, check out this guide.
Keep in mind that disability insurance is different from workers’ compensation, which covers only injuries that occur on the job. Disability insurance applies to an incident whether it was work-related or not.
How does disability insurance work?
When you have a disability insurance policy, if at some point you become disabled in an accident or become sick and are unable to work, you’ll receive benefits.
At least, that’s how it works in theory.
Multiple moving parts comprise disability insurance policies. You’ll likely encounter—and possibly need to make choices regarding—many of the categories below when you apply for a disability insurance policy.
Definition of disability
Every disability policy has a definition of what the insurance company considers “disabled,” but the most significant differentiator you’ll typically see is own occupation vs. any occupation.
Under a policy written as own occupation, the insured person will receive benefits if they are unable to perform the duties of their pre-accident or pre-illness job. Even if the disabled person could get a job doing something else, they would still qualify for benefits if they couldn’t hold their previous position.
Some policies give you the option of an own occupation rider for an additional fee.
Most policies limit the own occupation definition to the first two years of your benefit period, at which point the policy would change the definition of disability to any occupation.
Any occupation is different. With an any occupation policy, if an insured person were injured or became sick and couldn’t do their pre-accident job but could do something else for which they’re experienced, educated, or trained in, they wouldn’t receive payments. With any occupation, if you can work a job—any job—your policy won’t pay.
Own occupation contracts are more generous to the insured, where any occupation contracts are less likely to provide benefits to the insured. As such, own occupation might be more expensive.
Disability benefit amount
The insurance company determines a personalized benefit amount, which is the amount of money you’ll get per month if you become disabled. They don’t pull this amount out of thin air—most often, it’s a percentage of your income.
For those with high incomes, policies may limit your benefit to 65% of what you used to earn. For lower-income earners, it could be higher—up to 85%. Other contracts specify a flat rate they will pay based on how much you make.
In any case, you’ll never see policies that offer 100% of your pre-disability income because they want to incentivize you to rehabilitate and get back to work whenever possible. Insurance companies also want to reduce your motivation to make a claim unless you really need to. In other words, they’d rather not fund a permanent beach vacation after your accident, if you get the drift.
Disability benefit period
The benefit period is the time that your policy will pay disability benefits. You choose a benefit period, which is often 1, 2, or 5 years. Sometimes, disability coverage can extend up to age 65 or your entire life—but as with everything insurance-related, the longer your benefits might last, the higher your premiums will be.
Disability elimination period
An elimination period functions like a deductible in your health insurance. Rather than measuring dollars before coverage kicks in, however, the elimination period measures days. So, if you become disabled, you’ll have to wait the number of days specified by your elimination period before your policy starts to pay disability benefits.
Luckily, you can choose an elimination period that best fits your situation. The longer your elimination period, the lower your premiums. The shorter your elimination period, the higher your premiums.
Commonly, people choose a 90-day elimination period, but you don’t have to. If you have a sizable emergency fund and you think you can last months without cash flow, you may choose a longer elimination period (like 180 or 365 days). If you think you may need the cash sooner, you can typically select an elimination period as short as 30 days.
Disability insurance riders
Riders can provide a helpful boost to your coverage. Your policy may include some riders automatically, while others could cost extra. Here are some of the more common riders you’ll encounter:
Most insurance companies write disability policies with a “guaranteed renewable” provision which means the company cannot cancel your policy if you keep paying your premiums. This provision is tricky, however: Even though you are guaranteed the ability to renew your policy, insurance companies can legally raise your rates. Yes, you heard that right.
A non-cancellable rider offers more protection for consumers because, under this provision, insurance companies can’t jack up your rates. The other portion of non-cancellability is self-explanatory—the insurance company cannot cancel your policy if you faithfully pay your premiums.
In other words, guaranteed renewable is the second-best and non-cancellability is best in terms of consumer protection.
Waiver of premium rider
If your policy doesn’t include a waiver of premium, you’ll have to continue paying premiums even while you’re collecting disability payments. With a waiver of premium rider, your premiums will be waived when you begin receiving benefits and you’ll typically get refunded premiums you paid after your disability began.
Own occupation rider
The own occupation rider is sometimes an optional upgrade to policies written as any occupation. This rider adjusts the definition of disability to own occupation, which is much more generous about paying disability benefits.
Cost of living adjustment (COLA) rider
Typically, disability payments are paid in flat amounts, but the COLA rider increases your benefit amounts to keep up with inflation. The COLA rider kicks in after you experience a disability.
Future increase option (FIO) rider
The FIO rider (also known as a guaranteed insurability rider) allows you to increase your benefit amount at predetermined times without medical underwriting. The higher benefit amounts are specified in the contract, and you can raise them at either an age (like 25, 28, 31, 34, 37, and 40) or a life event (like having a child or getting married).
Return of premium (ROP) rider
If you select this rider, you can get a portion of the premiums you’ve paid into your policy, minus any claims. The return is usually at a specified interval, and the amount returned varies by company and policy.
For example, a company might offer you a 50% return of all premiums you paid into your policy every 20 years, minus any claims. So if you paid $300 a month for 20 years and never made a claim, you’d get a check for $36,000—tax-free.
The downside of this rider? It’s expensive. And if you happen to make a claim, that can eat into your return pretty quickly. Weigh the benefits carefully before you select this rider.
How much does private disability insurance cost?
Besides how you tailor your policy and additional riders you choose, insurance companies determine your premiums based on your age, gender, job, and income level. How much you pay is dependent on quite a few variables.
Practically speaking, if you’re more likely to become disabled, you’ll likely pay higher premiums. This principle is especially the case when it comes to your profession: A rodeo clown has a much higher chance of disability than a lawyer. As such, the rodeo clown will pay higher premiums for disability insurance than a lawyer—even though distracting bulls doesn’t bring in as much money as a charging lawyer.
For a quick estimate of what a disability policy might cost you, get a quote from Breeze in 15 minutes.
The bottom line on disability insurance
Disability insurance is a low-cost way to make a lousy scenario far better—for yours and your family’s financial security. And now that you’re in the know about the various coverage options and riders out there, you’ll likely find a policy priced right in your sweet spot.
If you’re considering disability insurance, be sure to buy from one of the top disability insurance companies.
Workers’ compensation is a state-required program that compensates workers who are injured on the job or experience a work-related injury, whether or not the employee was at fault or even being negligent.
Disability insurance covers accidents and illnesses that occur on and off the job or strictly off the job. Either way, disability insurance covers accidents that workers’ comp doesn’t.
Credit disability insurance is a type of disability policy that covers payment to a lender if the borrower becomes disabled. Purchased by the borrower, credit disability insurance prevents the borrower from defaulting on a loan if they were to become disabled.
Situations that fall under the normal outcomes of childbirth will not be covered by disability insurance.
However, many short-term disability policies cover complications that arise from pregnancy, like if your recovery from a C-section takes longer or other issues that may come up. To qualify, you’ll have to endure the elimination period first, and some policies have different elimination periods for pregnancy-specific disabilities, so read the fine print.
1 Social Security Administration, “Disability and Death Probability Tables for Insured Workers Born in 1997”