Do You Need Long Term Disability Insurance?

by Neal Frankle, CFP ®

So long as you work for a living you have to consider long term disability insurance. Don’t get me wrong, not everybody needs disability insurance coverage of course. I received an e-mail from a loyal Wealth Pilgrim a few days ago that illustrates the point.

Here’s his story:

Jim is about to leave his work. He’s made enough money and is going to support himself by living off his investments. In Jim’s email to me, his main concern was replacing the long term income disability coverage that his employer had provided. Once Jim quits, the long term income disability coverage goes away. Jim asked me how to replace it with a personal policy. I’ll answer Jim’s question, but first, a little background.

Important Note – Some people buy credit card insurance which is cheap and then they think  they don’t need disability coverage.  WRONG!   Credit card insurance is cheap for a reason – it barely covers anything.  I am not a fan of credit card insurance at all.

Why would anyone want to pay for disability insurance privately?

Disability insurance replaces (usually 60%) of your income in the event some physical impairment stops you from working. Keep in mind that more people lose their homes because of disability as apposed to premature death. That indicates you might be really interested in having this coverage. Need more statistics?

According to the Life and Health Insurance Foundation for Education, November 2005, there is a 60% chance that one out of every five people (between the ages of 30 and 55) will suffer a long term disability. I don’t like those odds and I’m sure you don’t either. This is serious stuff and Jim is right to ask questions about disability insurance.

How much coverage can you buy?

Usually, the insurance company isn’t willing to sell you as much disability coverage as you’d like to own? Why? Because then you’d have every reason to get hurt (or say you are), sit home and watch Dr. Phil, and collect those fat checks. That’s called “moral hazard”. Typically this insurance will only replace (up to) 60% of your gross income.

Are disability insurance benefits taxable or tax free?

If you buy the policy personally, any benefits you collect are tax-free. If  your company pays for the policy, the income is taxable if you collect on a claim. If you are  self employed it works the same way.

So if you want to know how much coverage you should buy, the answer is – as much as the insurance company is willing to sell you.

How do you collect benefits and for how long will you collect?how much disability insurance

You collect long term disability income benefits based on the kind of policy you purchase.  If you buy an “Own-Occupation” policy, you’ll collect if you aren’t able to perform the duties of the occupation you performed at the time you became disabled.

“Gainful Occupation” policies only pay if you can’t perform the duties of any occupation that you are reasonably qualified for as a result of your training, skills or education.

Now, we’re ready to answer Jim. But my guess is, you already know the answer.

Jim won’t be able to buy disability insurance once he retires because he won’t be working. Remember, Jim’s premise is that his money will do the working. His plan is to earn enough from investments in order to live. I don’t know what they call that where you live, but in Pilgrim Country, they call it “retirement”.

The one thing that Jim should consider is long-term care insurance. Those policies provide payments in case Jim has a long term illness. These policies help Jim pay for the expenses associated with such health problems. Disability policies don’t concern themselves with the expenses associated with illness. They only replace income you lose as a result of a disability.

What is your insurance game plan for retirement?


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