Long-Term Disability Insurance: You Likely Need More Protection Than You Have

Let’s start with a pop quiz: What’s an item that you need to own but hope never to use? Insurance! Paying for nothing sounds like a bad exchange, though that’s a short-sighted view when it comes to insurance because its true benefit lingers in the background if or until it’s time to pay out. While insurance touches nearly every part of your financial life, actually obtaining benefits is never ideal because it’s a sign that something undesirable has occurred.

Broadly defined, insurance is a “hedge against the risk of financial losses, both big and small, that may result from damage to the insured or [their] property, or from liability for damage or injury caused to a third party.” Ugh. Nothing about losses, damage or liability should excite anyone about receiving benefits, yet that definition expresses why insurance serves such an important need in many areas of our financial lives. Rather than self-insure against all financial risks in your life, paying premiums for an insurance company-issued policy transfers a large portion of your personal risk to a pool of other insurance customers. Paying premiums on a policy can help limit the amount of income you would have to put aside in case of damages, losses, or liabilities.

The Unexpected Should Be Expected

Before COVID-19 became a continuing global pandemic, the Council for Disability Awareness cited studies showing that less than half of American adults could pay basic expenses for longer than three months or be able to absorb a surprise expense of $400 or more without financial assistance. Additionally, less than half of Americans have insurance protection against the inability to earn income. The most common reasons that people are unable to work for longer than three months include back injuries, cancer, pregnancy, mental health issues (anxiety and depression), and injuries to muscles or joints. You may be surprised to learn that the average length of time that payments are made for a disability claim is just under three years. When many people do not have liquidity to cover more than three months of living expenses, the fact that payments for the average disability claim last only three years should create a sense of urgency to evaluate and/or improve your current protection.

A new wave of long-term disabilities is likely to spike from factors attributed to COVID-19, a nearly ubiquitous presence in our lives for close to two years now. In July 2021, infectious disease expert Dr. Claire Pomeroy observed that after at least 34 million Americans have survived a bout with the virus, 25% have retained long-term symptoms preventing them from returning to life as they knew it. She writes, “While the number of patients with persistent illness remains undetermined this early in the pandemic, estimates suggest that millions of Americans may enter the ranks of the permanently disabled.”

Needs Exceed Preparation

For reasons that are elusive, long-term disability insurance garners relatively little attention from either financial advisors or consumers, and as a result, many people are not adequately protected against a loss of earned income for as little as three months, let alone years into the future. Sobering data from the Social Security Administration reveals that more than a quarter of 20-year-olds will become disabled before reaching retirement age (which for them is 67). What’s more, those receiving Social Security Disability Insurance income benefits are more than three times as likely to die in a year as other people the same age. By law, only those who are chronically unable to work due to extreme illnesses or disability are eligible for Social Security Disability Insurance. For the relative few who are approved, average income replacement is less than $15,000 per year, “barely enough to keep a beneficiary above the 2018 poverty level ($12,140 annually).” Unless your income is $15,000 or less, federal disability benefits will not come close to replacing your earned income or satisfying your need to save for future goals. Fortunately, there are other options.

Slightly Better News, Likely Not Good Enough

For those offered group long-term disability insurance through their employer’s benefits package, the good news is that eligibility requirements are typically less stringent than with Social Security and the amount of income replaced is higher. However, the terms in policies vary considerably, and the amount of income replaced may still be a fraction of what you earn (and need to keep earning). Guidance from the Patient Advocate Foundation shows that policies typically replace 50%-70% of earned income and that eligibility is met by one of two classifications, known as “Own Occupation” and “Any Occupation.” After short-term disability insurance covers one to six months for minor illnesses or injuries, Own Occupation coverage will replace a portion of your earned income for up to two years, though only if you cannot function in your current or a similar role. Beyond two years, Any Occupation coverage generally applies, which only pays benefits if you cannot function in a role for which you are “reasonably qualified by education, training or experience.”

The following hypothetical, yet reasonable, example illustrates how Any Occupation coverage can be a tough concept to stomach. Let’s say your pre-disability job was as a traveling software sales manager earning $100,000 per year. You’ve collected 60% of that ($60,000) under Own Occupation coverage for a couple years, and now the Any Occupation qualifier is kicking in. Does your training also mean that you are qualified to work in an online customer service role from home instead of the sales manager role that required travel? If you are physically and/or mentally capable of performing a role, you could become ineligible for disability benefits and be expected to start working in another capacity. You need income, so you take the job — and another pay reduction from $60,000 to $50,000. If you are living on half the earned income you collected pre-disability, will you even be able to pay your basic living expenses in addition to medical bills? How would that affect your ability to save for future goals?

Bridging the Gap

Fortunately, there are options to fill the gap between pre-disability income and disability benefits that alone may leave your current and future financial life in disarray, which is the last thing a person or family already managing the stress of a chronic ailment or injury needs. In general, there are three avenues to pursue a long-term disability insurance policy (or policies).

• Start by identifying what your company offers as a long-term disability benefit and determine how close it can get you to your target coverage. Inquire if you can purchase additional coverage that may help fill the gap between your current income and what the default benefit pays. If your open enrollment period is many months away, proceed with the following steps in the meantime.
• Next, if applicable, explore any professional associations to which you belong or could join that offer self-paid access to group benefits. For example, some states and national associations offer various benefits to their members, allowing them to pay for perks while benefiting from group purchasing power. Doctors, dentists, accountants, attorneys and financial advisors are just some examples of occupations that have strong professional associations.
• If you’ve discussed the appropriate type and amount of coverage you need with your wealth advisor and what’s available to you through the first two options is not adequate, your advisor can work with you to purchase a policy through an insurance company (without conflicted sales pressure).

It is possible to own two policies that, together, can completely replace your current earned income. And the closer you can get to matching your current income with an insurance solution, the more peace of mind you’ll have that, if disability should strike, you will still be able to meet your living expenses while remaining on track to reach your financial and life goals.

Final Considerations

There are, of course, many other considerations regarding long-term disability insurance to keep front of mind as your plan develops. For instance, one key aspect is whether benefits will be taxable income or not. The general rule is that if an employer pays premiums for an employee’s long-term disability policy, the income benefits would be taxable income for that employee. If an individual, either through their company’s plan or their own personal policy, pays premiums for the policy, then the income from benefits would be tax-free. Taxable versus tax-free income may generate considerably different financial outcomes, so understanding this nuance is necessary.

Understanding how long-term disability insurance differs from worker’s compensation, in addition to Social Security Disability Insurance, is also important. When reviewing long-term disability policies, factors such as the net-of-taxes benefit amount, maximum length that benefits can be paid, the types of disabilities covered, waiting periods, renewability and/or portability, whether benefits are adjusted up for inflation, and other details must be explored.

It’s far better to invest the time to establish proper coverage while you’re healthy, rather than waiting until you’re rudely surprised and need the benefits, because by then it will be too late. If safeguarding your current lifestyle and future financial goals are important to you regardless of your ability to earn income, now is the time to talk with your advisor about making long-term disability insurance a fixture in your financial life.

Rob Ziliak is the Chief Experience Officer at Buckingham Strategic Partners.

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