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Filling the Gap with Disability Insurance

Photo of author, Nick Stebner, CFP®, CPWA®.
Nick Stebner, CFP®, CPWA®
Financial Strategist and Operations Manager

Many people who feel the need to financially provide for their families "in case the worst happens" often seem to have only a vague idea of how to provide for them if they are unable to work for a time due an accident or extended illness. Car accidents, for instance, can take place at any time at any age. What's your plan? How long will the cash in the bank accounts or the credit cards last if there's no income and you're not in the shape to work at all? If you have a spouse, do they start job hunting? What if their income-making prospects are significantly lower than the dollars coming in before? What kind of hit would your family take?

Planning for the Not-Quite-Worst

Many people confuse disability insurance with long-term care insurance. Long-term care insurance is intended to help shoulder at least part of the financial burden of a stay in an nursing home or similar facility. Disability insurance can be better thought of as paycheck-protection insurance in case someone is unable to work as result of an illness or accident. The odds of such are higher than those for an untimely death--even for younger workers--but that risk is often forgotten. And during a time like that when additional medical expenses are likely, the family has to be able to survive without the help of a payout from any life insurance. Disability insurance can help fill in that gap.

Disability coverage is commonly given as an employer benefit, but policies can also be bought directly with an insurance company. Coverage from your employer typically ends if you change employers, but coverage from a standalone policy would still be in effect. Coverage is often defined as short-term or long-term, with a standard short-term policy typically providing benefits for 1-12 months. A long-term policy typically will pick up after the short-term policy benefits expire and could last for a year or longer. Some even promise to provide benefits until the owner's retirement age. Benefits typically won't replace all of one's base compensation and won't replace any incentive, bonus or profit-sharing income. A common replacement ratio for both short- and long-term disability policies would be 60% of your base compensation, with some weekly or monthly maximums. For high income-earners, these weekly or monthly caps are pretty important details to be aware of. Most policies, short- and long-term, will have an "elimination period", which is a period of time between the disability and when the policy starts paying benefits. Think of it as a deductible, but instead of an expense paid in dollars, it's a built-in delay before benefits begin. All of these aspects can vary by employer.

Another point to note is, who pays the premiums for the disability policy? It's potentially important, since who pays for the policy determines whether the benefits are taxable income to the beneficiary when paid. If the employer pays the premiums, the policy's benefits will be taxable, reducing the beneficiary's take-home amount even further below their original base compensation amount. Benefits from a policy whose premiums are paid by you, however, would be tax-free income.

Defining "Disabled"

A final very important point is the definition of "disabled" in the eyes of the insurance company.

Benefits aren't limited to disabilities or injuries occurring at work or while working. Most policies offered by employers are offered as "any-occupation" policies, which typically define a disability as being unable to work at any occupation, even a lower-paying one. A construction worker who is injured and can't perform that job any longer but can work in fast food would likely not receive benefits from an any-occupation disability policy, even if taking a large pay cut. In contrast, an "own-occupation" policy would consider the policyholder disabled if they are unable to perform the same job as they did before an accident or injury. So the injured construction worker would collect benefits under an "own-occ." policy until he or she could return to that same type of work. Again, for high-income or specialized workers, an own-occupation disability policy could be extremely valuable. Also, to receive benefits, even from a standalone policy (not employer-provided), one has to be working at the time of the accident--not be in between jobs. Without a measurable income loss related to the disability, the policy won't pay benefits, unless it is a modified own-occ. policy.


Having some awareness of the potential pitfalls around disability insurance can you help not be caught short if you're temporarily taken down by an accident or long illness. Although we do not sell insurance policies or make commissions on them, we can analyze your existing disability coverage or help you in searching for additional standalone coverage. If either of those would be helpful to you, please contact your McKinley Carter financial strategist.

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