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We believe that your personal Cash Flow is the most important planning you can do. It naturally follows that we’re also very concerned with what happens if that cash flow stops unexpectedly.

Many people don’t believe they’ll ever become disabled and forego coverage altogether. The truth is, 1 in 4 of today’s 20-year-olds will become disabled before retirement1. When we consider the probability of disability and the consequences to the financial plan should disability occur, many times insurance will be needed to transfer that risk.

What is disability insurance?

Disability insurance on a high-level is very simple: benefits are paid if you become disabled. Things get complicated when considering the specifics around what type of policy is chosen, how much income to replace, what defines a disability, when to have benefits begin and how long they will last.

Types of Policies

In all our discussions around disability insurance, we’re referring to long-term disability. That is the tool that will manage the risk to your financial plan. Short-term disability plans have the nice feature of starting almost immediately. However, the benefits are only paid for short amounts of time, generally less than two years.

For long-term disability policies there are two ways to get coverage: group coverage or individual insurance.

Group coverage is offered through your employer or some other organization you are a part of. Group coverage will only cover you while you maintain your relationship to the group (if you get a new job, you can no longer be in the group policy). Group coverage generally has low limits for how much of your income will be replaced.

Individual policies are contracts between you and an insurer. There is much more flexibility in the design of the plan, but the costs are generally higher. As long as the premiums are paid the coverage remains in place.

How Much Income to Replace?

The first decision to make is to decide whether you want to replace your income or your spending. In general, replacing spending is the wiser choice as the premiums saved over insuring your entire income are better served elsewhere.

From there it will become easier to select how much income your policy should provide and what that looks like for your budget. There are several levers (discussed below) that can be pulled to align your budget with the policy characteristics.

What is the Definition of Disability?

There are two options to choose from here and the effect on the premium is substantial. Any occupation means you are unable to perform and work based upon your education and work experience while own occupation means that you cannot perform the tasks and duties related to your current job. In general, an own occupation policy will be more desirable, however it will come with a higher premium.

When Should Benefits Begin?

The elimination period is how long you must be disabled for in order to receive benefits. The longer the elimination period, the cheaper the premium will be. Ideally, an emergency fund would be in place to cover your living expenses during the elimination. You are self-insuring this period of time and should take that into consideration in your financial plan and as you select the elimination period.

How Long Should Benefits Last?

A disability policy that is going to protect you against the possibility of being injured and unable to work should protect you until you are eligible for Social Security retirement benefits. Anything less than this would not be providing the ‘catastrophe’ risk you may be looking to have covered.

There are many more smaller decisions to make when purchasing a disability policy. Some of these decisions include: the option to purchase additional insurance in the future, whether the benefits adjust for inflation and if other income offsets the benefit.

As always, you will want to discuss your purchase of disability insurance with your trusted advisor. When we review the disability insurance question, we always seek to provide clarity and purpose to your decision to ensure it aligns with your financial plan.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Please keep in mind that insurance companies alone determine insurability and some people may be deemed uninsurable. Guarantees are based on the claims paying ability of the issuing company.

1Council for Disability Awareness