Should You Replace Your Employee Disability Insurance?

When you leave your job, one thing you’ll have to consider is disability insurance. I received an e-mail from a loyal Wealth Pilgrim a few days ago with exactly that concern. Here’s his story:

Jim is about to leave work for good. He’s made enough money to retire from his current job and is going to support himself by investing activities. In Jim’s e-mail to me, his main concern was replacing the long-term income disability coverage that his employer had provided. Once Jim quits, his 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 let me give you a little background.

Why would anyone want to pay for disability insurance?

Disability insurance replaces (usually 60%) of your income in the event some physical impairment stops you from working. In light of the fact that more people lose their homes because of disability as opposed to premature death, 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 on the money to ask questions about disability insurance. If you’re interested in being self-employed, you should be interested in this subject too.

How much coverage can you buy?

Unlike term insurance, 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 hurt), sit home, watch Dr. Phil and collect those fat checks. That’s called “moral hazard.” Typically the coverage replaces (up to) 60% of your gross income, as I said. If you buy the policy personally, the income is tax-free. If your company pays for the policy, the income is taxable. So, to answer the question – how much disability coverage should I buy – the typical answer is, as much as the insurance company is willing to sell you.

How do you collect benefits and for how long?

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. There are other types of policies which we’ll discuss in another post.

Now we’re ready to answer Jim.

He probably won’t be able to buy disability insurance because he’s not working. He’s retired. Remember, Jim’s premise is that his money will do the working. His plan is to earn enough from investments in order to pay his bills. 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 do is get an LTC insurance quote (long-term care). Those policies provide payments in case Jim has a long-term illness. They can 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.