INSURANCE CENTER: Disability

What factors should I consider before buying private disability insurance?

Disability Insurance
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First of all, we're talking long-term here. For short-term needs, you are better off funneling pricey premium payments into a liquid emergency fund. This way, if you never need it, it's your money!

On to long-term...

As is the case with life insurance, there are two basic types of disability insurance: group (obtained through work or membership in an organization) and private (purchased on your own). Unlike life insurance, however, private disability insurance is almost always more expensive than group, often significantly so.

So, if you carefully examine your employer's plan and decide you need more disability coverage, start by looking in your own back yard. Some employer plans allow you to buy additional coverage -- often a boost from 60% to 80% of your salary -- through the same group plan, at bargain rates. Also, if you are a member of any groups, clubs, or professional associations, check those sources too.

If these leads don't pan out and you're forced to buy a private disability policy, it'll be expensive, but you may also find some nice advantages to ease the pain a little:

Some advantages to private disability insurance

  1. Benefits you receive if you become disabled will be tax-free, as long as you paid the insurance premiums with after-tax money.
  2. The policy will not be tied to your current job. This leaves you free to experience a mid-life crisis, heading off to the Himalayas with disability insurance in tow. More seriously, if you have entrepreneurial ambitions, it might be a good idea to lock in an individual policy while you can. Once you become self-employed, affordable disability insurance will be very difficult to find.
  3. If you are a highly skilled, highly paid specialist -- like a brain surgeon, a power forward for the Knicks, or a wedding DJ -- you may want disability insurance that locks in this exceptional income level. This more-expensive class of policies is called own-occupation coverage. Any-occupation coverage is the more-common -- and less-expensive -- group insurance option. Any-occupation policies require you to take lower-paying jobs in your field, if available, with no insurance payments to make up for any lost income.

Some important things to look for in private disability insurance

  • Be sure the policy is "non-cancellable." This guarantees that policy premiums cannot be changed as long as you pay them on time. Avoid "guaranteed renewable" and "return of premium" policies. These sure sound great, but only "non-cancellable" locks in premium costs.
  • Be sure the policy is non-cancellable to age 65.
  • Unless you have direct access to Nancy Reagan's astrologer, don't purchase an "accident-only" policy or one with a limited benefit term (five and 10 years are common). Sure, these policies are cheaper, but they don't cover disabling illnesses or the whole of your working life, respectively. Who knows what the future holds?
  • "Residual benefits" is an important rider. This benefit -- which can also come in the form of a loss of income policy -- pays the difference between your old salary, prior to becoming disabled, and the best salary you can get afterward. Not only does this protect you from the downside of any-occupation policies (being forced into a lower-wage career), it might also head off an awkward situation in which you are forced to choose between sitting at home (and collecting disability) or working part-time (and losing all disability payments).
  • If you can afford it, a cost-of-living rider will protect your future benefits from the ravages of inflation. Also, with a private policy, your "income" will be set at the time you take out the policy. You might want to increase this protected income level as your career progresses, without a medical exam. Check to see if this requires the purchase of a policy rider.
  • The waiting period, before disability payments kick in, acts just like a car insurance deductible. The more emergency savings you have, the longer you can wait for disability income, and the lower your premiums will be.
  • Watch for clauses that exclude pre-existing medical conditions or dangerous hobbies, unless of course you are in perfect health and define excessive risk as two cards on bingo night.
Believe it or not, this isn't a complete listing of all the important details regarding long-term disability insurance. If you decide to purchase a private policy, then you might want to work with an independent insurance agent or a financial planner. The Internet is a great source of information, but when a purchase combines high cost with this many potential pitfalls, it often pays to have an expert on your side.