The Retirement Corporation of America

Protecting Yourself Against Disability

DISABILITY COVERAGE IS the third insurance "leg" you should have under you as part of your financial safety net. It doesn't pay for health care. You have to rely on your medical insurance for that. You buy disability coverage to replace all or a good part of your income if you get sick and can't work for some period of time.

If you make less than $25,000 a year and have good disability coverage at work, you're decently protected. But if you make more than that and conclude the group policy doesn't provide as much as you'd like it to, you should also buy some individual disability coverage on your own.
Why You Need Individual Disability Coverage

There are drawbacks to most company plans:

Your employer's disability plan probably only covers you if you can't perform your regular job. Group coverage usually only covers short-term disability. A typical group disability plan replaces 50% of your income at the time you're disabled to a maximum of $5,000 a month for up to two years.

If you're still laid up when your group coverage runs out, you have to turn to state disability which usually only pays you for 26 weeks or to social security disability which is very hard to get. Worker's compensation only kicks in if you get sick or hurt on the job.

How to Figure How Much Disability Coverage You Need

A good rule of thumb is that your total coverage between what you have at work and what you purchase on your own should be enough to replace at least 60% of your current take-home pay, preferably 70%, for at least a year. Keep in mind that you will still have living expenses while you're laid up, and on top of that, any medical expenses your health insurance doesn't cover.

Here's how to get a more precise idea of the disability coverage you should have:

Step 1: Figure your bare-bones household expenses, not forgetting things like taxes, gas and maintenance for your car, regular medical and dental care, the kids' allowance and "walking around" money.

Step 2: How much is in your emergency fund? As we've discussed, you should have three-months' take-home pay tucked away—either in your credit union, or better yet, in a money market fund that's more likely to pay you a higher rate of interest.

If you aren't there yet, tack on the difference between what you do have in your emergency fund and what you should have to cover any unexpected expenses that might pop up. These could range from fixing the roof to an unplanned trip across the country so you and/or your spouse can help care for a relative or attend a funeral. These kinds of things don't stop happening when you're disabled. That three-month figure is only a target. A little more would be better.

Step 3: How good is your medical plan? It would probably cover 80% of your additional medical expenses if you were disabled, but you'd have to pay the other 20%. To get an idea of what your additional expenses could be if a serious illness put you out of work, consider what kinds of health problems you have now and which illnesses tend to run in your family. Heart problems? Cancer? How about high blood pressure which could lead to a stroke?

Step 4: Add it up. Chances are, the total comes to a startling amount.

Beware of a Tax Trap

You may have less disability coverage at work than you think because of taxes. Some group insurance plans let you buy disability insurance with pre-tax dollars. If you're self-employed, you can deduct your disability premiums from your income taxes.

But Uncle Sam always gets his due, one way or the other. If you buy disability at work with pre-tax dollars or you write off your premiums you have to pay taxes on your benefits when you collect them just when you're less likely to have the money.

On the other hand, you usually receive disability benefits from a policy you buy on your own tax-free because you've bought that coverage with after-tax dollars.

Buying Disability Insurance on Your Own

Finding good coverage at a reasonable price is difficult. Many companies have become gun-shy about offering this kind of insurance in recent years because of fake claims. Consider hiring a financial planner who has had clients who have filed disability claims. Find out if those clients had any problems with certain companies—whether their claims were processed in a timely manner, if they received their checks on time or if they had any other problems.

Ask the planner to recommend two or three companies and agents, then do some homework on your own before you buy. Whatever the planner costs, you should save in getting adequate coverage from a reliable company at a reasonable price.
Features of a Good Disability Policy

1. Partial Disability Coverage (sometimes called "own occupation" coverage). You may get sick, yet still be able to do some kind of work. But it may not bring in enough money to pay the bills. So your policy should be "job specific," meaning that it guarantees to cover you if you can't do the same kind of work you usually do. In other words, if you normally earn $30,000 a year as a nurse but develop muscle or back problems that keep you from doing heavy lifting, the insurance company can't refuse to pay you because of a lower paying job that requires no lifting.

If you can't afford a policy with job-specific coverage, the next best kind to have is a "modified occupation" policy or, as it may be called, a "reasonable occupation" policy. This coverage pays you only if you can't work at a job that is consistent with your education, training and experience. The lowest-cost disability policies are called "any occupation" policies. They pay you only if you can't work at any kind of job, much like social security.

2. Waiting Period. Some policies start in as little as seven days after you file a claim while others don't start paying you for as long as a year. The shorter the waiting period, the more expensive the policy. For most people, a 60-day waiting period makes the most sense. In the meantime, you have your emergency fund to fall back on. But you don't want to use every bit of that up—especially when you're disabled.

3. Residual Benefits Coverage (sometimes called "recurrent disability" coverage). This means the company offers a trial return-to-work program. It will continue paying you your benefits for a while after you return to your regular job to be sure you can handle it. This is a key provision to have.

4. A Noncancelable and Renewable Guarantee. The company can't drop you and you can renew the policy when your coverage period is up at the same rate. You and your financial adviser will have to shop hard to find a policy with a renewable guarantee. Most companies reserve the right to raise your premiums every time you decide to continue your coverage.

5. Inflation Protection. Look for a policy whose benefits keep pace with annual cost-of-living increases, so your payments maintain the same buying power. Since 1967 inflation has averaged 5.5%, although in recent years it has been around 2%.

Don't pay extra for a "return of premium" provision that promises to give you back all or some of your premiums if you never file a claim. It can make the cost of a policy prohibitive.

As we've discussed, that depends on what kind of coverage you want, whether an insurer considers your job dangerous or especially stressful—and typically, whether you're a man or a woman.

Many companies charge more to insure women because they have historically filed more disability claims than men. How much more? Often at least $100 a year more than men pay for the same coverage.

For a disability policy that promises to replace between 60% and 65% of your take-home pay, expect to fork out about 2% of your pre-tax income or about $1,000 a year if you make $50,000 after taxes.