The Basics of Disability Insurance

Insurance policies can seem quite complex, especially if you’re looking into disability insurance for the first time.

If you’re thinking about investing in a disability insurance policy but don’t know where to start, you’re in luck. We’ve put together an in-depth guide to everything you need to know about disability health insurance—from policy types to finding the best insurance company to filing a claim. You might be surprised by the options you have. Let’s start by breaking down exactly what disability insurance is.

The Basics of Disability Insurance

There are a few key takeaways to consider when it comes to disability insurance: 

• Most disability policies will cover up to 80% of your annual income for the period when you cannot work.
• Any illness or injury that keeps you from working your job will likely qualify as a disability, though this depends to a significant extent on the specific policy you choose.
• Third-party disability insurance is often better than disability insurance offered by employers, as the latter only include short-term plans and are void if you leave your employer.
• Benefits earned from your policy are not subject to tax, though an employer-sponsored plan may be taxable.

What Is Disability Insurance?

Disability insurance is a type of income protection that pays out a portion of your income in the event of a debilitating injury or illness. These payments are referred to as “benefits.” The type of income that a policy will cover and the amount of time you receive those benefits will depend significantly on the policy you choose.

There are three major types of disability insurance:

• Short-term disability insurance or STDI. This policy will pay up to 80% of your gross monthly income. It generally lasts between three and six months; only rarely is it longer.
• Long-term disability insurance or LTDI. This policy will pay around 60% or more of your monthly income. It can last a few years or even until you decide to retire.
• Social Security Disability Insurance or SSDI. This free disability insurance is offered by the U.S. federal government. It usually only covers residents with severe disabilities, and qualifying can be very difficult.

Some people may qualify for state disability insurance, though not all states offer such policies. These insurance programs, known as temporary disability insurance (TDI) plans, are essentially short-term policies that can be used in conjunction with secondary policies. Currently, only California, Hawaii, New Jersey, New York, Rhode Island, and Puerto Rico offer TDI policies to residents.

It’s important to understand the difference between STDI and LTDI, as they are similar and can be a bit confusing. STDI is intended to cover your income for a short amount of time should you become temporarily disabled. This coverage typically lasts up to six months and is frequently offered by employers. LTDI, by contrast, is intended to pay benefits for a longer period. The exact among of time depends significantly on your individual policy and can range from a few years to several decades. Once you reach retirement age, however, disability insurance will typically stop, and you will need to consider other insurance policies for long-term senior care. 

When thinking of disability insurance, people often imagine an injury causing a short-term disability. However, according to the Council for Disability Awareness, over 90% of claims that individuals file for long-term disability benefits suffer from illnesses, not injuries. Such illnesses include stroke, arthritis, back pain, and cancer.

One major question that many consumers have is simple: “Is disability insurance worth it?” In an article for National Public Radio, health policy reporter Michelle Andrews noted that LTDI could be one of the best investments you could make, especially if employers offer that coverage: 

“Benefits consultants agree that although long-term-disability coverage lacks the novelty appeal of some other benefits that companies are offering these days … it can prove much more valuable in the long run,” Andrews wrote. “If you become disabled because of accident, injury or illness, long-term-disability insurance typically pays 50 percent to 60 percent of your income, while you’re unable to work. The length of time the policy pays varies; some policies pay until you reach age 65. Many long-term-disability claims are for chronic problems such as cancer and musculoskeletal conditions. According to the Council for Disability Awareness, the average duration of a claim is nearly three years—34.6 months. Not everyone has savings to support them through that time. In 2015, when the Federal Reserve Board surveyed adults about household economics, 53 percent said they don’t have a rainy day fund that could cover them even for three months. More troubling, nearly half of respondents — 46 percent—said that faced with a hypothetical $400 emergency expense, they don’t have the cash to cover it.”

How Does Disability Insurance Work?

Essentially, disability income policies are agreements made between insurance providers and policyholders. When you make regular monthly payments, your insurance company agrees to provide a monthly benefit amount in the event that you suffer from a disability that keeps you from working at your regular job.

This type of insurance is used to replace a certain percentage of the income you have lost due to your disability. The percentage of this payout should be as close to your annual take-home income as possible, though most policies cover only up to 80%. This money can be used to purchase food, pay bills, cover rent or mortgage payments, and pay other everyday expenses until you can work again.

When you meet with an insurance provider, they will draft a policy that will provide quite a lot of information.

The first thing your policy will note is your premium payment. As with all insurance policies, your premium must be paid every month to ensure continued coverage.

Your policy will also detail what is and is not considered a disability; this is very important. One insurance policy may pay you benefits if you suffer an injury that makes it impossible to work your normal job but does NOT impact you enough to prevent you from seeking work elsewhere. Other insurance policies will not pay any benefits if you are able to find work in another industry, even if your pay is dramatically reduced.

Another important thing your policy will detail is how much money you will receive in benefit payouts. Your benefit is almost always based on your income, and you can expect most disability policies to pay between 60% and 80% of your annual income. Keep in mind that this is based on the job you held when the disability occurred. If you worked as an engineer, for example, you would receive benefits that reflect an engineer’s salary.

What Does Disability Insurance Cover?

The core purpose of disability insurance is NOT to cover your medical or long-term care needs; this is where total disability coverage would be necessary. Rather, normal disability policies are designed to cover a fixed amount of time in which you are unable to work your normal job because of an illness or injury that has left you temporarily disabled.

Your insurance policy will pay your benefit every month until you have recovered from your disability or your predetermined coverage period has ended. Benefits will cover your bills and the standard of living that you had before the disability occurred. The money goes directly to you—it won’t go to your medical provider or anyone else. Its purpose is to cover your existing lifestyle until you are able to recover.

When shopping for a policy, it is very important to ensure that you choose enough coverage. Your potential monthly benefit should be close to your average take-home pay. It may also be a good idea to purchase additional coverage in the event that your cost of living increases.

As noted above, disability insurance only covers a predetermined amount of time or the total time it takes to recover. Presumptive disability coverage, on the other hand, is a policy that consumers can choose in the event that an injury or illness is so severe that they will never be able to work again. These disabilities include everything from loss of limbs to loss of speech to blindness. Because of this, presumptive disability insurance has no elimination period, and you will receive your previous annual income in benefits for the rest of your life.

How Much Does Disability Insurance Cost?

For those who have employer-sponsored disability insurance, the employer is responsible for making premium payments. If you opt for an individual policy, you will have to pay a monthly premium. The cost of your monthly premiums can vary significantly with your personal health history, occupation, and policy payout needs. However, in most cases, you’ll be paying somewhere between 1% and 5% of your annual gross income every year, divided into 12 monthly payments. 

If you smoke or have a preexisting condition, your monthly payments will likely be more expensive. Similarly, if you work in a potentially hazardous industry, you will probably have higher premiums.

Takeaway

When it comes down to it, disability insurance can be an excellent choice for most individuals. It’s impossible to predict things like car accidents or sudden cancer diagnoses, and anyone could become disabled at any time. If you work in a high-risk industry such as construction or mining, disability insurance is even more worthwhile; just ensure that you select coverage that offers high payouts and payout timelines that can be adjusted.

Frequently Asked Questions

If I have LTDI coverage at work, do I need an individual policy, too?

It’s generally recommended to invest in a long-term disability policy rather than a short-term policy. Employers often choose to offer short-term coverage. However, if you’re lucky enough to have a job in which your employer offers long-term coverage, you likely won’t need a secondary policy that you pay for. However, some policyholders will “stack” different policies in order to obtain more features and coverage.

Who pays for STDI coverage?

When an employer provides STDI, the employer is responsible for paying for coverage.

What is not covered by disability insurance?

Disability insurance can cover many things, but there are some that no disability policy will cover. Typically, disability insurance will not cover medical or long-term care. It will also not offer benefits to policyholders over 65 years of age, as senior policyholders will likely need long-term care. Disability insurance is designed to replace some of your working income while you are temporarily disabled. There are other insurance policies, such as health insurance, that should be considered in the case of long-term disability.

Can I have two disability insurance policies?

Yes, you can. This is known as “stacking,” which can be beneficial because it includes the features of different carriers. This is recommended if you have found a policy that is almost perfect but is missing one specific feature that you want to purchase from another provider. Similarly, stacking can lead to larger benefit payouts, depending on the type of policies you choose