Disability coverage is designed to replace income lost during your working years in the event you become disabled and cannot perform the duties of your job. Most policies will pay benefits until age 65. Typically, employers that provide employee benefits offer disability coverage but there are a couple of reasons why you may want to supplement your coverage with a private policy. First, most employer policies provide a benefit that covers 60% of your base salary. But many corporate employees receive bonuses and other incentive compensation (stock options, restricted stock etc.) so that 60% of base salary is well below your actual income. Second, you lose that 60% employer coverage when you leave your company—so if you are ever in a job transition or decide to start your own business your only potential coverage would be from Social Security and would be minimal. A private policy will remain in force even after you leave your company.
For those not familiar with my story, I enrolled in a Certified Financial Planning (CFP) program while still working at Best Buy back in 2009 so that I had my career “Plan B” ready to go. One of the key takeaways I had from taking that program was that I needed more long-term disability insurance. Like many corporate employees, my annual bonus and restricted stock grants made up a significant portion of my income and that income was not factored into my disability coverage. So right after I finished the insurance portion of the CFP course I purchased an individual disability policy for the maximum they would write. That decision became even more important when I started my financial planning practice in 2014. To this day, the only disability coverage I have is that individual policy I purchased back in 2009. Without it I’m not sure I could have taken the risk of starting this business.
Disability is quite common. Data from the Social Security Administration indicates that about one in four workers in the US will eventually become disabled. While disability is more common for those with physical jobs, an estimated 10% of white collar workers will become disabled. What many people don’t realize is that disability insurance may be the most important insurance coverage to have since it insures that they have a level of income that provides for basic living costs.
I have encountered many people in a job transition who did not consider what would happen to their disability coverage once they left their corporate employer. Insurance companies will not write a disability insurance policy for someone with no income. Thus many people end up stuck without any disability coverage beyond what Social Security provides.
There are also tax considerations to think about. Typically, disability benefits received under an employer plan are taxable, whereas benefits received under an individual plan are not. If your company pays the premium, any benefit received if a claim is filed is considered taxable income. However, if you pay the premium, which you would under an individual plan purchased to supplement your employer coverage, any benefit received is tax free.
Here is an example of how this would work. Jim is a marketing director at XYZ Co. with an annual salary of $130,000 and an average bonus of 25%. His average monthly take home pay after tax is $8,000. He has disability coverage from his work for 60% of his base salary. In this example, we assume that Jim would qualify for a Social Security disability benefit of $2,000 per month, which would reduce any disability amount received under his employer’s group policy.
Scenario 1 – Jim becomes disabled while still employed at XYZ.
- If he does not purchase an individual policy, his estimated after-tax monthly disability benefit would be $4,000 ($2,000 from Social Security and $2,000 from the group disability plan). This represents a 50% reduction in his after-tax income.
- If he purchases an individual policy with a $4,000 monthly benefit, his total after-tax disability benefit will be $8,000 ($2,000 from Social Security, $2,000 from the group plan and $4,000 from the individual plan). This equals his previous income.
Scenario 2 – Jim’s position is eliminated and Jim becomes disabled during the time he is searching for a new job.
- If he does not purchase an individual policy his estimated after-tax monthly disability benefit would be limited to what he collects from Social Security, which is $2,000 per month. This would mean a 75% reduction in monthly after-tax income.
- If he purchases an individual policy with a $4,000 monthly benefit, his total after-tax disability benefit will be $6,000 ($2,000 from Social Security and $4,000 from the individual plan). This would mean a 25% reduction in his after-tax income.
In either scenario Jim would be much better off having purchased the individual policy.
Disability policies can be quite complex and difficult to understand. They include several optional riders, some of which I believe can be worth purchasing while others can typically be skipped.
Because of the prevalence of disability, the premiums can be costly. Deciding whether to purchase a supplemental policy will depend on whether you have spouse with income and whether you would be willing to adjust your lifestyle in the event something happens. Whether children are involved is also a factor, as is your age and the size of your existing retirement portfolio.
But what I find is that many people just don’t even consider it. Given the risk involved, I recommend you at least get a quote and review the math. I can help with this, so feel free to reach out.