Long-term disability insurance (LTDI) plays a crucial role for anyone who has not achieved financial freedom, especially high-income earners in specialized professions. A long-term injury or illness can be a financial catastrophe that prevents you from working while also having to pay expensive medical bills.
Throughout your working career, you are far likelier to become disabled than to die. According to the “Why Disability” booklet published by National Underwrite, men have a 43% chance and women have a 54% chance of becoming disabled at least once during their working years. Those are startling odds…
A well-written disability insurance policy will protect you financially. The gold standard for long-term disability insurance is an “Own Occupation” individual policy that is guaranteed renewable and non-cancellable with some additional features (known as riders).
The most expensive risk to take is losing your ability to work and turn the knowledge and skills you’ve spent years learning (your human capital) into a huge pile of money!
How Long-Term Disability Insurance Works
The idea of disability insurance is pretty straightforward – you buy a policy and pay a premium based on the amount of income you want to insure, and if you become disabled you (along with your doctor) file a claim and your insurance company will pay you a promised monthly income benefit until you recover from your disability or reach a certain age (usually 65-70 depending on policy) if you are permanently disabled.
How Much Income Protection You Need
The size of your policy depends on your expenses and lifestyle. Determine how much your monthly expenses are, keeping in mind premiums will increase based on the benefit amount. Expect to pay around 1-5% of your monthly benefit or $100 – $500 for a $10,000 monthly benefit, but this varies based on age, gender, occupation, and riders.
The benefits paid by your individual policy may also be tax-free federally, depending on how the premiums are paid (see individual versus group policies below). This means you will need less monthly benefit compared to your current monthly income since there won’t be any federal taxes (but benefits may be subject to state and local taxes depending on where you live).
While you don’t want to over-insure and pay for unnecessary premiums, you likely won’t regret having more financial cushion in the event of a health crisis than not being able to comfortably pay for your expenses and maintain your lifestyle. High-income earners have the advantage of being able to buy larger policies since insurance companies will limit benefits to a maximum percentage (usually 60%) of gross income.
Don’t forget that you also need to save for retirement even if you are disabled since you won’t be contributing to retirement plans (401k, IRA, pension, etc.) and your insurance policy will end after a certain age. Have enough coverage to cover both your living expenses AND retirement savings if you were to work until standard retirement age (or much earlier if you plan to FIRE).
Short-Term and Long-Term Disability Insurance
Should you have both short-term disability insurance (STDI) and long-term disability insurance (LTDI) policies? It’s good to have both, but a LTDI policy is more important.
Let’s take a look at the differences and why having both STDI and LTDI policies complement each other.
Source: TheRichHenry.com
Short-Term Disability Insurance (STDI)
STDI will typically pay you benefits for 3 – 12 months if you are disabled and will often be provided at work as an employee benefit that covers all employees under one group policy your company pays for. Most professionals do not need to go out and buy their own individual STDI.
STDI policies will typically have a waiting period (also known as an elimination period) of 7 – 14 days before they start to pay out. You can use a combination of your paid time off, vacation and sick days, and any other time off that you’ve accumulated during your elimination period to prevent gaps in your income before STDI begins to pay you.
Even if you do not have coverage through your employer, a short-term injury or sickness is not a financial catastrophe. These events can be self-insured by having an appropriate emergency fund and savings to hold you over until you recover and can return to work.
Long-Term Disability Insurance (LTDI)
LTDI typically has a waiting/elimination period of 90 – 180 days. You can time this with your STDI benefit period, which begins to pay out much sooner and will end once the LTDI elimination period is satisfied, allowing you to collect income from the day you become disabled.
Talk about peace of mind during an already stressful period! This is why anyone who has not achieved financial freedom should have a long-term disability insurance policy.
Individual Versus Group Policies
What if I already have both STDI and LTDI policies as part of my work benefits? That’s great! But you should still buy your own individual LTDI policy from an independent insurance agent.
Your employer provides coverage under a group policy, which is designed to cover a large group of employees regardless of their individual financial circumstances with no medical underwriting required, in exchange for cheaper premiums that are subsidized as an employee benefit.
Individual policies are superior because they are fully customized based on your individual needs and have a much stronger definition of disability.
In addition, benefits you get from an individual LTDI are tax-free at the federal level if you pay your premiums with after-tax dollars, while benefits from a group policy that your employer provides will be taxed regularly.
Keep in mind for a group policy your employer is the legal policyholder and can make changes to the terms at any time or even cancel the policy, leaving you uninsured. If you ever decide to leave the company you will also lose coverage under the group policy (i.e. not “portable”).
On the other hand, an individual LTDI policy is portable and will stay with you no matter where you work. As the policyholder, you are entitled to continue your coverage under a certain set of terms including the premiums you pay (“guaranteed renewable”) and the insurance company cannot cancel your policy unless you decide to stop paying the premiums (“non-cancellable”).
Own Occupation Definition of Disability
While the concept of disability insurance is straightforward, the actual product can be complex. Unlike life insurance where a payout is clear if someone is dead, being “disabled” is complicated and the legal definition of disability in your policy plays a big role in whether or not you receive benefits.
As previously mentioned, the best long-term disability insurance is an individual policy that is guaranteed renewable and non-cancellable, with an “Own Occupation” definition of disability for the entire length of the policy. This means you are considered disabled if you are unable to perform the material and substantial duties of the job you were working at the time of your disability.
Example 1: A surgeon who gets into a car accident and is unable to perform surgery would be considered disabled since they cannot do the “material and substantial duties” of their job. The insurance policy should kick in and pay them income until they recover and can perform surgery again.
Example 2: If the same surgeon has permanent nerve damage to their hands and can never perform surgery again, but can still teach at a local medical school, they are still considered disabled under a LTDI policy with Own Occupation definition of disability.
The LTDI policy will pay them full benefits for not being able to do surgery even if the surgeon is earning six-figures at a teaching job. That’s the power of a strong definition of disability.
Be careful of weaker legal definitions of disability such as “Any Occupation” which won’t consider you disabled if you can work at a job that you are reasonably trained and suited for, or a “Modified Own Occupation” (also known as “Own Occupation, Not Working”) definition which will not allow you to work in any other field.
Another thing to watch out for that’s common in employer group policies is an Own Occupation definition that only lasts for a certain amount of time (e.g. 24 months) from when you first become disabled, then switches into Any Occupation definition which may not qualify you as disabled afterward.
With an individual policy, you can have the Own Occupation definition of disability for the entire length of the policy, ensuring your earning potential from a long and prosperous career.
Social Security Disability Insurance (SSDI) – The Safety Net
While SSDI provides modest disability benefits, it’s really a last resort due to its strict rules and high rates of denial. According to recent statistics on SSDI rejection rates, over 70% of initial applications on average are rejected. While it’s possible to appeal a denial, the process can take months or even years and is never guaranteed, all while you have no income coming in.
To qualify for SSDI you need to earn enough work credits (one credit for every 3 months of work) in a job that pays Social Security taxes and wait a 5 month elimination period before benefits are paid out. Under SSDI’s strict definition of disability, only long-lasting or permanent medical issues that prevent you from doing any form of work or are expected to result in death will allow you to qualify.
The Social Security Administration (SSA) defines disability as:
- The inability to engage in substantial gainful activity (SGA)
- Due to medically determinable physical or mental impairment(s)
- That has lasted or is expected to last for a continuous period of at least 12 months or is expected to result in death
Example 3: The surgeon who qualified for individual LTDI benefits would not qualify for SSDI benefits if they cannot go back to doing surgery but can physically do another job, no matter how unskilled or low-paying.
Can you imagine spending years of education and training as a surgeon and end up flipping burgers at McDonalds?
Lastly, SSDI benefits are modest, with an average monthly check of $1,700 in 2023 according to the SSA since the program is designed to cover basic needs and not replace all lost income.
While SSDI is a nice safety net to have, you should not be relying on it as your only source of disability insurance protection.
When To Stop Paying For Your Disability Insurance
A STDI policy is a nice to have. A LTDI policy is a must-have (either an individual policy by itself or combined with a group policy from work) until you have achieved financial freedom.
Why? A short-term health issue can be covered by an emergency fund or other savings, so having no coverage is fine since you can self-insure (most employees will have some sort of coverage from work anyway).
However, a long-term or permanent health issue that puts you out of work can be a financial catastrophe. Having no insurance or only having group coverage is not enough when you know there is better protection that exists.
Once you have achieved financial freedom, feel free to stop paying premiums and drop your policy since you can now self-insure. Until then, play it safe and protect yourself against unaffordable risks.
Don’t Take Risks You Can’t Afford
Don’t take the risk of not having adequate disability insurance, especially if you can afford to pay the premiums in exchange for ensuring your financial well-being. Don’t be penny wise, pound foolish.
Work with an independent insurance agent who can help you shop around for policies from the Big Five disability insurance companies that suit your needs. Don’t rely on a captive agent who only sells products from a single insurance company.
While the premiums might give you sticker shock, keep in mind the reason disability insurance is expensive is because it actually gets used! Disability insurance is all about mitigating risks that you cannot afford to self-insure against, so you are essentially paying for peace of mind that you will be covered financially even if you cannot work.
Don’t be tempted to go for a cheaper policy just to save on premiums. A cheaper policy will usually have a broader definition of disability or missing critical riders that leave you vulnerable to additional risk. You get what you pay for so don’t let price dictate your actual insurance needs.
Protect your most valuable asset, your ability to work and earn money at a high rate, until you achieve financial freedom. An individual own occupation long-term disability insurance policy is the best protection you can get. Not having it would be penny-wise and pound-foolish.