I occasionally receive questions from readers that ask about a number of financial issues, and a recent reader asked: “Is is smart to buy disability insurance?” Of course, without understanding someone’s complete financial situation, it is impossible to give a straight “yes” or “no” answer, I can provide some insight as to when it is smart to buy disability insurance.
Before jumping into the question, I just want to recap what disability insurance is if you aren’t familiar with it. Simply put, disability insurance is a policy you purchase that will supplement your income in the event of a disability that keeps you from working. This insurance is meant to allow you to keep a stream of income to help you stay on top of your finances if you will be out of work for an extended period of time.
An Example of How Much it Can Benefit You
If you’re 35 years old, earning $50,000 per year, and become disabled for the rest of your life, you’ll be missing out on around $1.5 million in income between age 35 to 65. And this doesn’t even take into account raises, promotions, or benefits that you may have earned over this period. So, an average person could be putting a couple million dollars or more at risk by not carrying disability insurance. When you think of it that way, it is kind of scary, isn’t it? You may have a $500,000 term life policy to insure against your death, but you may be neglecting even more by not protecting against a disability.
When Disability Insurance is a Good Idea
Do you earn income? If so, buying disability insurance is probably a smart thing to do. You’re far more likely to become disabled for six months or more during your working years than to die. In fact, even at age 30, you have a 1 in 5 chance of becoming disabled for a year or more. Even one year without income could be devastating to your finances. At best, you may have to deplete your emergency savings. At worst, you won’t have enough saved up to cover all of your expenses during this time and have to resort to taking on expensive debt. In some cases, a long-term disability can force people into bankruptcy.
When Disability Insurance Not Such a Good Idea
Even though you can clearly see the benefits of protecting your income against a disability, it isn’t for everyone. For example, if you’re married and both of you work, you could be in a situation where two incomes aren’t a necessity to pay the bills. You or your spouse may be working part-time just for extra money, or otherwise still be able to get by without both incomes. In a case like this, it might not make sense to pay disability insurance premiums on both parties, so money could be saved by only covering one of you.
One of the biggest hurdles is that disability insurance is another premium to pay, and if money is tight, this is almost always out of the question. If you can hardly keep up with your minimum payments and monthly bills, buying disability insurance may do more harm than good. Think of it this way: if you can hardly keep up now, with full income, even if you have disability insurance, at best you’ll still be treading water, and more likely, only earn a portion of your income from a claim, and end up heading for bankruptcy regardless.
It isn’t a fun topic to discuss, but it is real. Disability is the number one cause of home foreclosure and bankruptcy. You need to protect against it if you can, but if your finances are already in disarray, you need to get that house in order before you can take on another monthly payment to obtain insurance.
What About Social Security Disability?
Good luck. Social security benefits are hard to qualify for, and even if you do, the amount you receive is very low relative to what your pre-disability income was. I’ve written about how hard it is to qualify for, and receive Social Security disability benefits in the past. So, don’t count on it, and view any benefits you receive from Social Security as a bonus.
How to Obtain Disability Insurance
First, you should check with your employer. If you’re a full-time employee with benefits, there is a good chance that you receive some sort of disability insurance. In some cases, your employer will pay for a short or long-term disability policy automatically, and in other cases, you may have the option to purchase additional insurance through their group plan. Obtaining coverage through a group plan will almost always be cheaper than going out and buying coverage on your own, so check there first.
If your employer doesn’t offer coverage, then you’re going to be on your own to find a policy. Shopping for any insurance policy requires some homework since there are a lot of shady sales reps and companies that may appear to offer low-cost coverage. Many of the large insurers will offer disability, or work with a company that does. Check with your current insurance companies, whether it is homeowners, life, or otherwise and see what they provide.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
You should also buy a policy with after-tax dollars where possible: The reason is simple - benefits paid by a policy purchased with after-tax dollars are not taxable. This means you could use 100% of your benefit payment for your living expenses
I'm one that thought I would never need disability insurance, but because is was very reasonable through my work, both long and short term, I carried it. In 5 years with my company I have been on short term disability for 82 weeks (expected total of 114 weeks) due to 3 surgeries and 2 series of ovarian cancer treatments. I was on long term for 2 months, working part time. This time I may also roll into long term disability...God willing, hopefully not for long. But worst case, I'm facing that it could be until the end of my life. So insurance is insurance and you never know when you might need it. I couln't have survived financially without it.
As someone mentioned before, when it comes to short term disability it is better to have an emergency fund. For long term disability however, insurance is definitely needed for most people.
long-term disability insurance isn't cheap. my employer doesn't provide it and the one quote I got from MassMutual was around $250/mo.
I would definitely like to get quotes from other companies and the problem is that there just aren't that many companies that sell this insurance. If you have some suggestions I'd be grateful.
on the other hand, payments from such policies are free from income tax, so don't dismiss 50%-of-salary policies. sure it's less than your paycheck but not all that much.
I have been ponderign this question the last 2 weeks (nice timing on the topic!): If things are very tight, would it be better to drop the life insurance and pick up long term disability? Especially for someone like me that can only get life ins through work that will pay 2x my annual salary. (basically a $90K life ins policy - which isn't much)
JC, while it is true you can't take an employer's disability plan with you when you leave, you will pay a significant premium if you decide to buy your own coverage. The average annual premium for a group LTD plan for 2007 was $226. That is less than 20 dollars a month.
On the other hand, when buying your own LTD plan, the premiums are typically between 1-3% of your annual salary. For someone making $50,000 a year, that is a $500-$1,500 premium. So, you're typically better off to pay the much lower group rate while you do have that job. If you leave, you won't have income anyway and the insurance doesn't matter. When you get a new job you can see if they offer it, and if not, then decide to buy an individual policy if you have to.
You should also get long-term disability rather than short term. For short term, your emergency fund should cover the 6 or so month that you might be disabled. Long term covers a long time.
Also, don't get disability insurance through your company. You can't take it with you if you were to leave or get laid off.
"What About Social Security Disability?
That's a good one! My father was disabled for about a year and a half. Collecting SSI requires an attorney to get anywhere with them. The system is set up to avoid fraud and in the process, makes it very difficult to get any help whatsoever.