Disability Insurance

As a young professional, individual disability insurance is one of the easiest ways to protect one of the largest assets that you have. This asset doesn’t look like most - it’s not the account balance on your 401(k) statement, and it’s not the estimated value of your home. It is the present value of your ability to earn a future income, human capital.

Let’s take a look at an example. Sarah is a 30 year old accountant that owns her own tax preparation, planning, and bookkeeping business, which nets her $100,000 per year. Since she is still early in her career, she hasn’t amassed a large sum of money in her 401(k) or home equity, as she is still paying off the last of her student loans.

However, the asset Sarah does have is the ability to earn income year after year, using her skills and expertise. To keep things simple, we will assume Sarah plans to work until age 65, or another 35 years. We will also assume she is able to increase her income by 3% per year, to keep up with inflation. This means that the present value of her future income earning potential is valued at about $2,150,000!

Her earning potential is clearly her largest asset at this stage of life, and one she ought to protect. Individual disability insurance is one of the easiest, and most affordable, ways to protect against the loss of such an asset.

Here are 10 things to know about individual disability insurance:

  1. Age Matters: As with other types of insurance, the cost of insurance increases as you age. With individual disability insurance policies, the cost is locked in for life when you purchase the policy, making it beneficial to purchase when younger.

  2. Sex: Males will pay less in premiums than females for disability coverage. This is the exact opposite of life insurance, but for the same reason. Males have a shorter life expectancy than females, making it less likely for males to have a claim on their disability insurance policy than females.

  3. Tobacco: Nicotine usage can increase premiums by 25% - just one more reason to kick the habit.

  4. Occupation class: Disability insurance premiums are priced on a number of factors, as you are reading here. One of the factors is the insured’s occupation, as the riskier the job, the more likely one is to become disabled during their career. Insurance companies will look at day to day duties of insureds and price their policies accordingly.

  5. State of Residence: Each state has their own department of insurance that regulates and approves plans, premium levels, and premium increases. The cost of disability insurance varies based on what state you live in.

  6. Income: Earned income, S Corp distributions, stock options, pension, investment interest, and all other sources of income are taken into consideration by the insurance company when underwriting a policy. Due to this evaluation, individuals with more unearned income (income that would continue in the event of disability) have less of a need for disability insurance coverage.

  7. Benefit Amount: Insurance companies look at all the sources of your income as stated above and generally allow coverage up to 60 percent of that amount.

  8. Benefit Period: Disability insurance can be taken out to cover a specific amount of time or until a certain age. Benefit periods of 2 years, 5 years, or to age 65/67/70 are most common. The shorter the benefit period, the lower the premiums will be.

  9. Elimination Period: The elimination period is the number of days that elapse from the date of disability until benefits start to pay out to the insured. For individual coverage, elimination period choices are generally 30, 60, 90, 180, 365, or 730 days.

  10. Riders: These are “add-ons” that can be a good choice to help keep your coverage up to date, without having to purchase an additional policy. A “Future Increase Option” allows you to increase your coverage while you are still healthy, while a “Cost of Living Adjustment” increases your benefit amount while on claim.

Bonus: It is important to understand the difference between “Own-Occupation” and “Any-Occupation” policies. An own-occupation policy will pay benefits if you are not able to perform the duties for your specific occupation (being an accountant in our example above). Any-occupation policies won’t pay a benefit unless the insured is totally disabled and is not able to hold any occupation based on the education and skill level they have obtained.

If you have questions or comments on anything discussed here, feel free to send me an email - ross@lyndalefinancial.com or Tweet me @rossvmenke.