Disability Insurance Dissected

Tuesday, July 22nd, 2008 by Charles Mayfield, CFP®


The statistics are alarming, but then again…that is what statistics are designed to be. I rarely meet someone that doesn’t have life insurance and yet we are nearly 6 times more likely to become disabled before age 65 than die. For most folks in the corporate world, disability insurance is usually a given. Your employer pays for some benefit. However, what are you truly getting? How can it curtail the onset of a disability that incapacitates you in the short/long term?

There are several things to consider when analyzing your disability insurance. I want to spend a few moments going through each of those:

What is protected? Traditional group plans typically protect between 50 & 60% of your salary. In some cases bonuses/commissions can be covered but it is rare. If the bulk of your compensation comes from bonuses or commissions, you should be aware that it is most likely not covered by your disability plan.

How long am I covered? Most plans will cover you to age 65 with some extended coverage if you are still working. However, you should plan on benefits stopping when most people traditionally stop working. There are plans that have shortened benefit periods (2,3,4,5 Year Benefit Periods). These are usually reserved for the individual marketplace.

Are the benefits tax free? Usually no! Most employers pay the premium for you and take a deduction for premiums paid. That ultimately means that the benefits are a taxable benefit to you. This is an important concept to understand. If the benefit is taxable and they are only covering 60% of your salary, we are now in a situation where potentially less than 40% of your income is actually going to paid out to you. Obviously, if you are paying taxes on the premiums paid toward your disability insurance…the benefit is tax free.

What is the definition of disability? This will vary with the insurance carrier. However most of the language is the same. The trigger comes when you can’t perform the ‘duties and material obligations of your occupation’ (also called your Own Occupation). You usually have OwnOcc coverage for a 2 or 3 year period of time. After that, you must seek a job to which you are educated and capable.

Does my insurance go up with my income? Yes, in one of two ways. The first, if your benefit is calculated as a fixed percentage your salary…then as your salary increases so does the benefit. The other way is if your benefit is a flat $ amount…there are two types of riders that allow you to increase coverage:

- Benefit Increase Provision: Allows you to increase your benefit every year based on inflation. You typically pay for this increase

- Cost of Living Adjustment (COLA): This benefit will start increasing the monthly benefit once you become disabled

  • * This benefit is expensive and typically not worth it
  • * It could be 10+ years between buying the policy and actually becoming disabled. At that point, your benefit is so far behind inflation, you’ve paid for something you didn’t use.

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