Disability Insurance Basics

| April 5, 2012 | 0 Comments

According to the National Association of Insurance Commissioners (NAIC), more than half of Americans say they would be unable to pay their bills or meet their expenses if they became disabled and could not work for a year or longer. Research on the reasons for personal bankruptcy has shown that prolonged medical bills are often either a significant contributor or direct cause of personal bankruptcies. For example, a study by the Robert Wood Johnson foundation in 2009 suggested that more than 60 percent of bankruptcies between 2001 and 2007 were caused by medical bills.

For working age Americans, there is a higher likelihood of becoming disabled than there is of dying prematurely, so protecting yourself (and especially your family) from the loss of income that may come with disability is critical to preserving your finances. Disability insurance pays a portion of your previous salary if you become disabled due to injury or a serious illness and are therefore unable to work. Exactly how long, and under what circumstance the policy will pay depends on the policy terms. But for many people, it can also be the difference between a couple of difficult years and financial ruin.

There are two main types of disability insurance:

• Short-term disability insurance replaces a portion of a policyholder’s salary for a short period, usually between three to six months, following a disability.

• Long-term disability insurance coverage generally kicks in after you are unable to work for at least six months. How long this coverage lasts, and how much of your income is replaced will depend on the features of the policy you have chosen.

In thinking about what kind of disability coverage you might need, you’ll want to think about the following factors:

• How much money will you need to cover critical non-discretionary expenses and the number of years you’ll need your coverage. Keep in mind that disability insurance typically covers at most about 60 percent of your pre-disability income.

• Pre-existing health conditions, your age and your occupation will all impact the cost and availability of long-term disability insurance.

• Long-term disability insurance often includes a waiting period of up to a year before benefits are paid. The longer the waiting period, the lower you premium will be.

• If possible, look for a “noncancelable” policy, which guarantees that your coverage can’t be cancelled or your premiums increased.

Disability insurance considerations change with your age and stage of life.

• Young single people without dependents may still need disability coverage because if they become disabled and can’t work, they could become a burden on their parents or siblings.

• Young families today often rely on two incomes to make ends meet. The loss, even temporarily, of one income could be devastating. Even established families paying (or saving) for college could be significantly affected by the interruption of a breadwinner’s income.

• For seniors or empty nesters, the choice is more difficult. Premiums are higher and the benefit periodsare shorter (age 65 or 67). Disability coverage is often replaced with long-term care insurance or life insurance at this stage, but still may be appropriate.

Disability insurance is an expensive, long-term commitment, so it is important to do your homework before you buy it. It’s equally important to get an objective opinion about how a disability policy fits into your risk management strategy, and a CERTIFIED FINANCIAL PLANNER™ professional (who is not also selling you the insurance) can be a great place to start. In next month’s article, I’ll discuss some of the features to look for in disability insurance policies.

This column is prepared by Rick Brooks, CFA, CFP®.  Rick is Vice President for Investment Management with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management.  Rick can be reached at (858) 755-5166, or by email at brooks@bfadvisers.com. Rick and his family live in Mission Hills.

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