Most people don’t even think about disability. It’s sort of the ninja of personal finance. It silently hurts you. The reason I say this is because there is no announcement in the newspaper and there are no big events held. Something bad happens and you end up in near seclusion as you try to recover. Usually the only people that are around to help and support you are your family and friends. Unless you are one of those people you never realize what someone has to deal with when they become disabled.
Maybe you are one of the lucky one’s that has group disability coverage through work. You really, truly want to believe that your coverage will be there to help you if something were to happen. Well here’s 7 ways that group disability coverage will fail you.
- It covers 60% of your income. Most group disability insurance covers up to 60% of your income. Can you live with that big of a pay cut? Don’t forget to add on the extra medical bills from the accident that caused the disability. Then there are the medical bills from the rehabilitation. Well we can ignore those for now. Make a list of your five biggest bills (mortgage, car payment, taxes, etc.). Now which two aren’t you going to pay?
- You’re employer is nice enough to pay for it. Isn’t that nice of your employer to pay for your group disability insurance? I would think so too at first. From an IRS standpoint though, if your employer pays for the coverage that means you don’t pay taxes on that money. Now if you were to become disabled, since there were not taxes paid yet, the benefits are now taxable. This means that if you are in a 15% effective tax rate, then your 60% coverage just got cut down to about 50%.
- You make bonuses and/or commissions. There are a lot of people out there who have a large part of their income tied to bonuses and/or commissions. Did you know that most group disability insurance doesn’t cover these at all? Usually they only cover base salary. This means that if you have a $100,000 base salary plus an extra $50,000 through bonuses and/or commissions, then when you factor in #1 & #2 above you are now down to about 33% coverage. The pay cut just keeps getting bigger.
- There is also a cap. Most group coverage will cap your monthly coverage amount. The most common cap is between $5,000-$6,000 per month. To give you an idea, each $1,000 of month coverage, covers $20,000 of salary at 60%. So a $5,000 cap will cover the first $100,000 and a $6,000 cap will cover the first $120,000. If you make more than that, you are taking an even bigger pay cut.
- There is a social security offset. Most group disability insurance will offset your benefit by the amount you receive from social security. If you’ve been reading this thinking that you’ll have some extra money on top of your disability benefit, don’t count on it. Some companies won’t even pay you the social security portion until your coverage has been denied by social security (which will most likely happen when you apply anyways).
- You can go work somewhere else. With disability insurance there is a feature called own-occupation. This means that you are unable to perform the duties of your specific occupation even if you are able to work in an other occupation. Good group disability coverage will cover your own-occupation for a period of 2 years after that if you can work anywhere (yes, even McDonald’s) then you receive no more benefits. Notice I said ‘good’ coverage, a lot of policies don’t even have the own-occupation benefit.
- You can’t contribute to your 401k when you aren’t working. No one ever thinks of this. If you are not working you cannot contribute to your company 401k. I have yet to see any type of group coverage that will account or help with this in any way. Most individual disability insurance policies will have a rider or stand alone feature that will continue to contribute to your retirement for you if you were to become disable (yes, this costs extra).
If you ever get a financial plan done it should include an analysis of your disability coverage. A lot of times and individual disability insurance policy is needed to supplement your group coverage in order to provide adequate protection for you and your loves ones. If you are unsure about your coverage you should consult a financial professional or get an insurance assessment.
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Great post! The social security offset is the killer! People think they’re going to get that 60% of their income, but surprise surprise there’s a snag.
What’s amazing though is that even though the cost for a supplemental DI policy is roughly 1-3% of your income to insure 100% of your take home – most folks would rather not even look into it because they don’t want to pay for “insurance that they may not need”.
.-= Jason @ Redeeming Riches´s last blog ..This Week in Personal Finance – January 29, 2010 =-.
Plus most people don’t realize how hard social security disability is to actually collect. You make a great point about cost. I purposely didn’t bring it up in the post but like you say 1-3% to insure you income. It can be that inexpensive. Truth be told a lot more people become disabled during their working years than die.
Excellent information. I was not aware of the last few points.
Yes it’s true. If you went looking for individual disability insurance, there is only one company, that I know of, that has own-occ built into their definition of disability. For most companies/policies it is a rider (add-on) to the policy. There is also a few companies that offer standalone retirement protection. These policies will contribute to a fund (very similar to retirement) if you are unable to contribute to your retirement.
Excellent point about own-occupation (vs. any-occupation.) One place I worked at when I was an employee (and not a consultant) offered own-occupation coverage _only_ for people who made more than a certain salary threshold. i.e. managers and executives. Most of my co-workers weren’t aware of the difference in types of coverage and that just top-dogs had the better kind!
When I first went out on my own as an independent consultant and had to shop for an individual LTD policy I made sure to get coverage with own-occupation until age 65. That was 12 years ago, and even though I went back into full-time employment once during that time period, I maintained my individual LTD policy because it was clearly better.
But- a good individual LTD policy can be expensive! To mitigate the cost, I opted for a 6-month deductible on my individual LTD, instead of 60 or 90 days. I maintain an emergency fund to make sure the 6-month waiting period isn’t too long to wait before LTD benefits kick in.
@Chris
The most important part of disability insurance is the definition of disability. There is so many variations of the definition that it is a bit daunting. I think that is one of the biggest reason why financial professionals usually aren’t very knowledgable about it.
Thank you for sharing your story. You bring up some great advice. Just as with most types of insurance the more you are responsible for up front the less expensive it will be. For disability insurance the deductible you referred to is called the waiting or elimination period.
Great post! One small comment having the 60% is better than nothing but not much.
@Daddy Paul
You are exactly right. 60 is a whole lot better than zero. The reason I wrote this is to help people realize that when they are expecting 60% they probably should really only expect 35-40%.
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