Disability Income Insurance Checklist

When asked the question “what is your biggest asset”, most people will say “my house” or “my retirement plan.” But the truth is that our ability to earn an income is our greatest asset. Consider this — the earning capacity of a thirty year old making $50,000 a year with a three percent salary increase each year for the next 35 years is more than $3,000,000. Very few have houses or retirement plans worth more than $3,000,000 combined. 

Our ability to earn an income is our greatest asset; yet oftentimes it is uninsured or underinsured. This checklist will help you analyze your existing disability insurance to determine if your coverage is sufficient.

The Definition of “Income” is the Basis for Payment

Most personal disability insurance policies are comprehensive. They can insure many sources of income including salary, bonus, commission, overtime, and sometimes retirement plan contributions. 

However, most employer policies are not as comprehensive. Obtain a copy of the policy from your human resources department and determine exactly what income is insured. You may learn that some of your income (bonus, commissions, overtime, etc.) is not covered under the employer’s group policy.

Neither personal nor group disability policies cover 100 percent of your income. Both generally insure 60-70 percent of income, although your employer policy may be limiting. The benefit could provide 60 percent of income up to a stated maximum monthly benefit. Consider this example:

• $4,800 > the $3,000 per month maximum
• $3,000 is the benefit received

How Do Taxes Affect the Monthly Benefit?

Generally speaking, if the disability income insurance premium is paid with after-tax dollars, the benefit received will be tax-free. But, if premiums are paid with pre-tax dollars or someone else pays the premium on your behalf,  the benefit may be taxable. This is often the case with employer-provided disability insurance. 

Let’s revisit our previous example to illustrate how taxes affect the monthly benefit. We determined our maximum monthly benefit is $3,000 per month and let’s assume the employer pays the premium. The $3,000 benefit is taxable income just like your earned income. If we assume a 25 percent tax bracket, the actual benefit received is $2,250 ($3,000 x 75 percent). 

When not disabled, this individual receives $6,000 per month after taxes ($8,000 x 75 percent). The difference in income is a staggering $3,750 in our example ($6,000 - $2,250). Few can absorb a $3,750 pay cut. This example highlights how the definition of income and the subsequent taxation can significantly impact your take home disability income benefits.

What is the Definition of “Disability?”

Another key provision inside personal and group disability policies is the definition of “disability.” Some policies have favorable language like “the insured is unable to perform the substantial and material duties of their occupation.” Other policies will have less favorable language such as “the insured is unable to perform the substantial and materials duties of their occupation or any other occupation for which the insured is qualified by education, training, and experience.” The latter of the two definitions favors the insurance company at claim time. 

It is also important to determine whether you must be totally disabled before benefits are received. Most quality personal and group insurance policies cover total and partial disabilities, but do not assume your policy provides such benefits. Check with your insurance agent if you have a personal policy or you human resources contact if you have a group policy. 

Many disability claims start off as a partial disability or transition from a total disability to a partial disability. If your personal policy does not provide for partial disability benefits, consider revising your policy. If you group policy does not cover partial disabilities, consider obtaining a personal policy to supplement your group coverage. 

Other Provisions

There are many more important provisions within a disability policy including:

• Waiting period – how long you must be disabled before you receive benefits. Most policies have a waiting period of 90 to 180 days, so be prepared to self-insure for a three to six months of expenses.
• Benefit period – how long the will benefit last. Most policies have a benefit period of age 65, the traditional retirement age. Some policies, however, may pay a benefit for only two years. Review your personal policy and your group policy to make sure you are adequate covered. 

Our ability to earn an income is our greatest asset. It is an ATM of sorts. Make sure your ATM machine is adequately insured so you do not run out of money at the most inopportune time…when you become disabled.