Disability Insurance for the Self-Employed – How to Get the Right Coverage

by Neal Frankle, CFP ®

Disability insurance for self-employed people is super important. Yet it’s often neglected and/or misunderstood. If you love being self-employed and want to stay in business, you owe it to yourself to learn a little about this subject. If not, you stand the real chance of kissing goodbye to everything you’ve worked so hard for.

disability insurance for self employed

Just to bring this home, let me ask you a question. What poses more of a risk to your family’s financial security:

a. premature death, or

b. long-term disability?

If you answered (b), you are right. In fact, the number one reason that people lose their home is illness. The number four reason is death. Do you need term life insurance? If so, you should have disability coverage too.

According to disablitycanhappen.com, 180 people are going to become disabled by the time you finish reading this post. 85,000 every day. And most of these disabilities are NOT caused by freak accidents. They are caused by back injuries, cancer, heart disease and other illnesses.

During your working years, you are more likely to face disability than death. According to the Life and Health Insurance Foundation for Education, nearly one out of every three workers will suffer a disability lasting three months or more at some point during their career.

When you’re disabled, you cost a lot of money to keep around. If you die prematurely…well…there’s “one less egg to fry” if you know what I mean.

If you’re self-employed, you simply have no choice. You have got to safeguard your family by getting yourself a disability policy. It’s a smart small business idea.

Here is a quick primer on how to buy your disability policy if you’re self-employed.

Background

Disability policies compensate you if you become disabled. The amount they’ll pay, the length of time they’ll pay and the conditions under which they’ll pay are the details you are most concerned with. Let’s start with the conditions under which the insurance company pays.

If possible, try to get a policy that pays if you can’t work in your own occupation. Some policies only pay if you can’t work in any occupation…but that stinks.

Let’s say you’re a mechanic and you lose the ability to use your right hand. You therefore can no longer be a mechanic. In fact, the only job you can find is at Food Mart as a one-handed grocery bagger.

While you used to make $75 an hour as a mechanic, now you can only make $12. If you have a policy that covers your own occupation, you collect. If you have a policy that covers any occupation, you don’t. That’s because you can still work.

A policy that covers “Own Occupation” is more expensive than “Any Occupation” of course, so you have to consider that. And here’s something else to consider.

You may not care if your policy is “Own Occupation.” Let me give you an example. I make money as a financial planner because I have knowledge, can access that knowledge and can communicate. If I couldn’t communicate, I probably couldn’t do my job…or any other job either. In other words, if I was unable to do my job, I probably couldn’t do any other job either. In my case, it might make sense to have an “Any Occupation” policy. It will save me money and probably be just as effective. See if that logic applies to you as well.

And if you go with the “Own Occupation,” beware. Make sure your policy doesn’t pull a fast one on you. Sometimes they do this by giving you “Own Occupation” during the first few years and then switch to “Any Occupation” after that. That stinks. Read your policy.

How long does the coverage last?

Try to get a policy to cover you to age 65, when you retire. You won’t be able to buy a policy that extends beyond that point. And it may be tough to even get a policy that goes that long. Many companies want to sell you coverage for only five or 10 years.

How long before the benefits kick in?

Most companies won‘t pay you for the first 90 or 180 days. This is called the elimination period. The longer the elimination period, the lower the premium. But if you don’t have much saved to tide you over during that period, you should try to get the shortest elimination period possible.

How much will the company pay?

The most any company will offer is 60% of your income. This is for two reasons. First, your benefits are tax-free (unless your company pays the premium rather than you as an individual). As a result, you shouldn’t need more than 60% of your earnings.

The next reason the benefits are less than you earn is because they don’t want to give you an incentive to make a claim. Even still, if you are a rated risk, the company may not offer you even that much. Sometimes, it’s an issue of taking what you can get.

Insurance companies don’t like self-employed people. It’s hard for us to verify stable income, so the insurance companies are at greater risk. (The longer you are in business the lower this risk becomes, so don’t give up.)

Make sure that your policy is guaranteed renewable.

This means that as long as you pay your premiums, the company has to renew your policy and can’t change the terms or premiums (unless they do so across the board for everyone in your risk class. This doesn’t happen often, so it’s not worth worrying about.)

Buying disability insurance is very important. When I bought my policy, it was very difficult to find any company willing to write the insurance. As a result, I got less than I wanted. Basically, I took what I could get because some coverage was better than no coverage. I haven’t had a claim (thank goodness), but I’m still happy I have that coverage.

One way for you to reduce the cost is by offering a group plan. Unlike most retirement plans for self-employed folks, the business owner can be discriminatory and offer some benefits to some employees while offering lower or no benefits to other employees. If you do this, you may qualify for a group plan, get a reduced rate and still save money.

 

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{ 9 comments… read them below or add one }

Dave March 6, 2014 at 8:53 AM

You mentioned you did purchase Short Term Disability Insurance even though almost no one will take Self employed people.
Who might I ask did you go with? I don’t see anyone on the internet except Mutual of Omaha advertising heavily to insure us self-employed people.
Thank you.

Reply

Neal Frankle, CFP ® March 7, 2014 at 7:06 AM

Dave – I bought it 20 years ago. I do not know if they still sell to new applicants and I can’t really plug any company on this site. Apologies. I will however write about disability insurance and how to get it for self-employed shortly. Thanks…

Reply

Susan April 26, 2013 at 8:09 AM

We are self employed and would like to get disability. We have been turned down. What company worked with you? Could you email me so I will be sure to get your answer? Thank you!

Reply

Jerry March 25, 2012 at 2:09 PM

This is an often looked over insurance choice. But, it is very important if you are self-employed. You must have some way to support yourself or your family if you are unable to work. Having it leads to peace of mind so people should start to take a look at it more seriously.

Reply

Michelle October 19, 2011 at 9:32 AM

Hi, I am a beautician, working out of my home. I have started getting cortisone shots in my hands because the tendons are wearing away, due to my work. They would like to do surgery but I am putting it off because if I’m not working, I’m not bringing in money. Do you think anyone would issue me disability insurance with this preexisting condition? Thanks , Michelle

Reply

Alfred November 4, 2010 at 4:51 AM

Neal, are you aware of any associations or organizations that one can join that offer “Group” benefits of some sort?

Reply

Neal@Wealth Pilgrim November 4, 2010 at 6:46 AM

Sadly…I am not.

Reply

Ethan June 21, 2010 at 6:51 PM

Just a note on the after-tax nature of the benefits. As Neal points out, this assumes that the premiums were paid with after-tax money. If your company is paying for your disability insurance, make sure they are doing it on an after-tax basis! They should already be doing so – no good insurance broker would let them do otherwise. But you are the one that will take the loss if they aren’t, so make sure.

Also, consider an individual policy even if you have coverage through your work. You might have a great, paid policy through work for a decade or so – fine. But what if you leave that job when you are 40, and become self-employed? Disability insurance at that age is expensive even if you haven’t had any significant medical problems or prior claims. If you have, it’s downright prohibitive.

The bottom line: if you decide that disability insurance is part of your pre-65 financial plan, you need an individual policy. You can check on the portability feature of your company plan but generally they are mere toys thrown in to satisfy company requirements. They do not allow you to walk away from the company and maintain a flat premium rate til age 65, which is what you want.

Reply

Neal@Pilgrim June 21, 2010 at 12:58 PM

It’s still important. And you bring up a great point. If someone who works at home has an illness that prevents them from working, what is going to replace that income?

You and I are in similar situations and face the same risks. We may have fewer risks than a parachute instructor, but we still face risks. Right?

Reply

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