What's the difference between short-term and long-term disability insurance?
Short-term disability insurance covers a percentage of your lost salary should injury or illness knock you out of work for more than a few days. (It bears repeating the old adage here: Do NOT run with scissors.) Payments generally kick in when you have exhausted any available sick leave. You might see a large chunk of your salary early on, but payments are often reduced to 60% of your salary, or less, after a few weeks. Duration of benefits varies by policy, but six months is typical.
Long-term disability insurance is a more typical insurance product in that it protects you from catastrophic illness or injury, including tragic twists of fate that permanently end your ability to earn a paycheck. (A wood chipper is NOT a toy, Fool.) These policies usually pick up where short-term disability policies leave off. Some last only five or 10 years, but you want one that covers you until age 65.
Let's focus on short-term disability right now, since long-term issues will dominate the remaining questions. When it comes to missing work for six months or less, most people have a number of sources for help:
- Paid leave: If your job provides sick leave and emergency leave, chances are you already know how many days you get and whether these carry over from year to year if you don't use them.
- Workers' compensation: Most employers are required to provide workers' compensation benefits that replace a portion of your income if you are unable to work, temporarily, due to an accident that occurs in the workplace or while on company time doing company work. These benefits vary dramatically by state.
- Automobile insurance: If you are injured in a car accident, your auto insurance may include payments to cover medical costs and lost income. Alternatively, you could sue the other guy to kingdom come.
- Emergency savings: There is probably no better argument for maintaining adequate liquid emergency savings than short-term disability risk. You may want to align the size of your emergency fund with the projected shortfall in your short-term disability insurance over a hypothetical six-month absence.
But I hate having savings in taxed, low-risk accounts!
We do, too, but we sure sleep better on top of some liquid emergency funds (we recommend paper currency, since coins can get uncomfortable). Regardless of who you are, dependents or no dependents, fate is likely to pay a visit at some point.
As you can see from the above list of options, six months in bed recovering from, say, severe back pain caused by clearing boulders from the backyard, is likely to force you into living off 60% of your current salary. And this "rosy" outlook assumes your employer provides short-term disability insurance.
If you are counting on raiding retirement funds to cover short-term emergencies, be careful. IRA rules do allow for disability withdrawals before age 59 1/2 without a 10% penalty, but you have to prove that "your condition can be expected to result in death or to be of long, continued, and indefinite duration." In other words, withdrawals to cover short-term work absences are likely to be penalized.
There are also provisions for early IRA withdrawals, without penalty, to cover substantial medical costs and health insurance premiums should you lose your job. But, again, these won't apply to basic living expenses over the short term. Check your employer-sponsored retirement accounts for similar rules governing loans and early withdrawals, if you're stashing your emergency greenbacks there.