Disability insurance coverage is important because illness and injury happen, and when they do, you don't want to compound that stress with financial hardship.
It’s easy to fall into the trap of thinking "it can't happen to me," or to think that disability only happens with freak accidents or dangerous jobs. For me, what really drove home the point that disability includes well-known illnesses that become increasingly common with each decade of life was when five friends in their 30s were diagnosed with cancer over the course of about two years.
Choosing a disability insurance policy can feel overwhelming. Here at AboveBoard, we focus on making the choices clear, so you can decide what's the best fit for you. This post breaks down the terms you need to know and most important decisions.
The 5 key items to look at when choosing disability insurance coverage
#1 Monthly benefit
The monthly benefit is how much money the insurance company will pay you each month if you're disabled, meaning you cannot work due to illness or injury.
Your monthly benefit needs to be enough to cover household expenses and save for retirement and other goals, like college savings or a home purchase. With most disabilities, you can expect to make a recovery eventually, but the last thing you want after years of treatment or rehabilitation is to feel like you're now years behind on retirement savings and your dream of retiring at age 65 is now pushed back.
Keep in mind that when you pay for a policy yourself, the benefit is not taxable—any benefit you choose is free and clear to cover your expenses and build your savings.
The tax-free nature of individual disability policy benefits is the opposite of how your workplace coverage most likely works. Most (but not all) workplace plans are paid for by your employer. That means that any benefit payments to you would be subject to both personal income tax and payroll tax. Be careful if you have a number in your head about your workplace coverage and think, "great, that should cover my critical expenses"—you might be missing the federal, state, and local taxes you pay on your income plus the ~7.5% payroll tax.
# 2 Waiting period a.k.a. elimination period
The waiting period (or elimination period) is how long you have to wait to start receiving benefits, starting from the time you are unable to work due to illness or injury.
If you take one thing away from this post, let it be this: don't buy a disability insurance policy with a 30 day or 60 day waiting period. Make sure you ask, "how much would it cost if I chose 90 days instead?" and then run the math on how much the savings are. What you will find is that the 30- or 60 day waiting periods are usually not worth it. They are so much more expensive than policies with 90 day waiting periods that if you saved the difference in premium, in under ~3 years, you’d be able to fully cover that extra month or two of waiting period IF you experience a disability or for any other emergency that can strike (a job loss, an unexpected major expense with your home or car, etc.).
For most people, 90 days or 180 days is the right choice for the waiting period. What you'll usually find is that 90 days is not much more expensive than 180 days, and if you ended up experiencing a disabling illness or injury, you'll for sure have been better off with the 90 days waiting period.
However, there are several situations where 180 days can make sense:
- Your employer offers very generous short-term disability benefits lasting up to 180 days, and you feel like your career path is likely to keep you at the employer or another employer with similarly generous benefits (typically workplace plans replace 60-67% of your income, with that benefit being taxable to you, and the more generous plans replace 80-100%)
- The difference in price between 90 days and 180 days waiting period appeals to you, and you're comfortable with the idea that if you experience a disabling illness or injury, you'll need to wait ~6 months (an extra 3 months) before receiving benefits
There are also 1 year waiting periods, but the savings on these versus 180 days are usually not that great. While occasionally they can make sense, a year is a long time to wait if you're going through a serious health event or recovering from a traumatic injury. Most disabilities last 2-3 years, so one year is a big portion of most disabilities.
#3 Benefit period
The benefit period of a disability insurance policy is the maximum amount of time that you can receive benefits for, during the time you are disabled.
The choices for benefit period are usually 2 years, 5 years, 10 years, until age 65, until age 67, or until age 70. Like I mentioned above, most disabilities last 2-3 years. Examples would be treatment for cancer, recovering from a heart attack, rehabilitating from a severe car accident or stroke, and many people experience more than one such event in life (a recurrence of cancer, a second cardiac event, etc.).
Some disabilities last much longer than 2-3 years, but a person with the diagnosis can still expect to live for the duration of their working lives. Examples of these types of disabilities would be more severe manifestations of multiple sclerosis, Parkinson's disease, or arthritis.
Particularly in families where there are two income-earning adults with somewhat comparable earnings power and lifestyles modest relative to their means, a 5 year benefit period can be a reasonable way to balance budget and protection goals. The trade-off here is that—if one or both receive a diagnosis that results in more than 5 years of disability—they need to stand ready to make other choices, like relocating to a lower cost of living area. For some people that sounds fine; other people like the idea of being able to keep life going as normally as possible without being forced to take on additional drastic changes.
In families where there is one income, one adult earns a disproportionate share of household income, or the family's chosen lifestyle requires both incomes, a policy where the benefit period extends until your target retirement age is usually your best bet.
#4 Own occupation versus any occupation
Own occupation coverage pays you 100% of your monthly benefit if you, due to injury or illness, are unable to work in your occupation, even if you can work in another occupation. I generally recommend that you ask yourself, "are there special physical capabilities required to do my job, where I can reasonably imagine an illness or injury that would make me unable to do my job, but I could do another job?"
If the answer is yes, you probably need an own occupation policy.
Here are examples of jobs where own occupation is usually the right choice:
- Medical fields: surgeons, dentists, veterinarians, or other doctors who rely on their fine motor skills and/or physical strength to perform their job functions
- Professional fields requiring the physical stamina to maintain a rigorous travel schedule or handle significant stress: attorney at high-pressure/long hours firm, investment banker, trader, private equity investor, corporate executive
Not everyone needs own occupation coverage because own occupation is a stronger policy.
#5 Residual disability or partial disability
Residual disability or partial disability benefits pay you a portion of your monthly benefit if you are partly, but not totally, disabled. Examples of this would be that you're able to work 2 days/week during cancer treatment, or you're able to work 3 days/week during your physical rehabilitation from a severe car accident. When you're undergoing a significant health event, it can be emotionally very comforting to be able to work some when you can. A residual or partial disability benefit can help ensure you get "made whole" for the parts for your job you can no longer fulfill.
Additional features to consider
#1 Future increase option
A future increase option offers you the ability to increase your coverage in the future without having to prove you are still healthy. This can be a very helpful feature for people who expect to have a significant future increase in their income or future coverage needs. This often comes up for people who are early- or mid-career and for individuals who are just beginning to expand their families (and will have all the accompanying expenses of raising children to consider in future benefit needs).
Importantly, different carriers have different approaches to how they handle this feature. Some carriers have specific administrative requirements to keep this feature going and are pretty strict. For example, they might send you a notice once every 3 years, and you must reply to their snail mail notice and accept at least half of any increase you're eligible for or risk losing the feature. Other carriers take the opposite approach and are super chill about the feature, not requiring any communication until you decide to make an increase. The former are usually free, and the latter you usually pay for, but sometimes there's not really a difference in price anyway. We can help you suss out the features you feel are worth it for you.
#2 Cost of living adjustment a.k.a. cost of living increase ("COLA"/"COLI")
This is a feature that sounds great, but usually does not work quite the way people expect it to. The big surprise usually comes from the fact that the inflation adjustments only begin once you are on claim. So if you buy a $10,000/month benefit today and go on disability leave in 15 years, your first payment is $10,000. There's no adjustment for the fact that 15 years have passed since you bought the policy. (Note this is the opposite of how inflation adjustments work with Long-Term Care policies, where you start getting benefit adjustment from the date of purchase.)
In that same example where you go on claim for the first time15 years after buying the policy, let's imagine you stay on claim for 2 years. If inflation is 2% in your second year on disability leave, then you'll get payments for $10,200/month during your second year on claim. It's more, but not by much.
The scenario where you would really wish you had COLA is if you had a very long-term disability, like a degenerative illness that is unlikely to be fatal in the medium-term, particularly if it started any time soon.
Oftentimes, we find that it's a smarter move to simply buy a higher starting benefit, rather than the COLA adjustment. That way, you can partly protect yourself from inflation, but also enjoy a higher benefit the moment you go on claim. We can show you the quotes both ways, and you can decide what feels like a fit to you.
#3 Catastrophic disability
A catastrophic disability rider pays you extra if your disability is so severe that you require long-term care. It's usually a fairly expensive rider and not a common experience. There are clearly some working age people who do require long-term care as the result of injury or illness, but it's much more likely that you will have this need in your older years. The best approach is usually to handle your long-term care coverage separately from your disability coverage, but we are happy to show you the quotes both ways if you would like, so you can decide if it feels worth it to you or not.
#4 Non-cancelable versus guaranteed renewable
Many policies include a non-cancelable feature (you don't have to elect it), meaning the insurance company cannot raise the price on you, up until a specified age (usually around age 65). Other companies give you a choice. If you don't choose non-cancelable, you're usually choosing "guaranteed renewable".
Guaranteed renewable means that the insurance company must offer you coverage each year up until a specified age (usually around age 65), but they could raise the price.
If you're considering a policy where non-cancelable is optional, a key question to ask is, "how often has that happened before, and what is the process by which it might happen in the future?" For some carriers, they have an outstanding track record of not raising prices; others, not so much. Importantly, it's worth understanding a bit about how such a price increase would actually work.
An insurance carrier cannot unilaterally decide to increase the cost of your guaranteed renewable disability in a given year. It's totally different from, say, a coffee shop that can simply decide, "we're raising the price of our sumptuous green tea banana bread" (filed under things I miss about our pre-COVID-19 office location).
To make a rate increase on their clients, insurance companies must file a request to increase with the state regulator, and the state regulator must approve the increase.
Regulators generally frown upon price increase requests. Rate increases can and do happen, but they usually happen in the context of an insurance company realizing they made a mistake pricing their prior business, and their state regulator is getting concerned that the price increase is necessary to keep the insurance company financially strong. So in some situations, people might reasonably expect to save a bit of money today, in exchange for the possibility of a rate increase in the future.
Different choices make sense for different people
Check out some examples of real-life clients and see how the different coverage options can come together.
Lydia* has worked hard at an NYC Big Investment Bank to build the lifestyle she enjoys today, and she likes knowing she can maintain it in any scenario: car accident or ski injury, cancer diagnosis, severe multiple sclerosis, etc. She's single today, but interested in having children within the next few years, with or without a partner. She decides on a $15,000/month disability income insurance benefit with a 180 day waiting period (workplace benefits are very solid for the first 6 months) and until age 65 benefit period to complement her existing workplace coverage. As an equity research analyst who loves her job but can envision a scenario where the physical demands of travel might not be workable in some scenarios, she chooses an own occupation policy. Since she’s a white collar professional in a field where staying front-of-mind for clients is important, she can envision many scenarios where she might be able to work part-time but not full-time if she were navigating a health crisis of some kind, so she goes for a residual disability feature, too.
Ramesh* makes $175,000/year at his software company, and his wife, Fariha* makes $200,000/year as a marketing professional. Their family lives in the Bay Area and is quite committed to their kids' private school, but otherwise they have pretty simple and inexpensive tastes. They save a decent amount of money each year, and their savings are on very solid ground from when Ramesh sold his prior company. He wouldn’t want to move houses or pull his kids out of private school if, say, a cancer diagnosis left him unable to work for 2 years. But if he had a disability lasting much longer than 5 years, he and his wife would probably want to move back to her hometown of Denver near her parents anyway, and the cost of living would be lower. In that scenario, they are confident the family could be fine on Fariha's income alone. Ramesh decides on a $8,000/month disability income insurance benefit that would begin after he’s been disabled for 90 days and would pay out for a maximum of 5 years. He skips own occupation and goes for any occupation—he loves making software; if he can't do that it's because he can't do any job—and decides that dropping non-cancellable in favor of guaranteed renewable is worth saving 8% to him (with a carrier that has never increased prices on its clients before).
As you can see, there are many combinations of coverage options that can work for your situation and goals. At AboveBoard we pride ourselves on giving you the information to make informed, empowered decisions about your coverage needs. Take our quick assessment to find what’s best for your protection goals and your budget.
*All names and personal details have been changed to protect privacy.