A home is likely one of the largest purchases you will ever make, so it may surprise you to hear that it is actually not your biggest asset. The ability to earn a continuous income far surpasses the value of a home. Though most people know how much insurance coverage they have on their homes, very few understand what coverage they have on their income. Most people assume that their employers will continue to pay their salary in the event of an accident, but rarely do they take the time to find out if that coverage exists, what the terms might be, and if there are any other options. We are careful when picking insurance for our cars, our health, our homes, and our belongings, so why be careless about insuring our incomes? It is the very thing that drives all other assets.
Types of Coverage
There are several ways to insure your income in the event of a disability:
Emergency fund: Having a cash reserve earmarked for an unexpected lapse in income can cover short-term disabilities. The common benchmark for liquid cash reserves is three to six months of living expenses. If you are self-employed, a safer benchmark is 12 months of living expenses.
Short-term disability insurance: This coverage is often provided by employers, either at no cost or as a buy-in option. Short-term disability coverage usually starts seven to 14 days after an accident and commonly covers your income for 60, 90, or 180 days. Although this insurance sometimes covers your entire income, it may provide only partial coverage (60 percent is a common coverage offering).
Long-term disability insurance: This coverage is sometimes available through your employer, and usually kicks in once short-term disability coverage ends. Coverage amounts are typically 60 percent or 70 percent, although this can vary from group to group. Coverage may have a maximum benefit length, such as five years or 10 years, but many plans last until age 65.
Typical Group Benefits
Some employers do not provide long-term disability coverage. In this event, an individual is wholly responsible for insuring her income through an individual long-term disability policy. Other employers will provide 60 percent of your salary, beginning on the 91st day post-accident and continuing for the length of the disability, up until age 65. Many employers have begun giving employees the option of paying a premium for this benefit, which would either increase the percentage of income covered (usually to 70 percent) or make any benefits paid out tax-free.
Who Pays for the Coverage Matters
Taxes will be paid on disability coverage at some point. The party that pays for the coverage determines when the taxes will be paid. When an employer provides coverage at no cost to you, they will usually receive a tax benefit for paying that expense. That means you would pay taxes on any benefit paid out to you. If you purchase an individual policy, you use post-tax dollars to pay the premiums, which means any benefit paid out to you would be tax-free. Therefore, if your employer allows you to purchase an option on your group policy that makes the benefit tax-free, you should take advantage of this opportunity.
Income vs. Salary
Pay close attention to the language used by your group long-term disability policy, especially if you receive bonuses or commissions. “Income” typically includes these sources of income but “salary” typically includes only your base salary. This difference can equate to quite a bit of money for some employees. If you have any questions about what is covered, do not hesitate to reach out to human resources for clarification.
Where to Purchase Coverage
There are only about a dozen companies that provide long-term disability coverage. I recommend consulting with a Certified Financial Planner™, who can point you to a broker if they are not licensed themselves.
In my line of work, I’ve heard too many reasons for foregoing disability insurance. Here’s how I respond to the most common — and flat out misguided — excuses:
Excuse: Disability insurance is a voluntary expense.
Reality: Income is necessary to continue your lifestyle. Could you really live without your income? Then why are you still working?
Excuse: It won’t happen to me. Millennials — who have only been in the workforce for less than 15 years and perhaps have not seen coworkers or friends succumb to an injury or illness yet — are especially guilty of employing this invincibility reasoning.
Reality: The longer we remain in the workforce, the more likely it is that we’ll see cases of poor health and accidents derailing plans. Research shows that more than a quarter of today’s 20-year-olds will become disabled before they retire. By the time you have your first health scare and want the coverage, you may no longer be able to obtain it.
Excuse: If something happens, I can rely on my parents.
Reality: Even if your parents are willing to do so, chances are that they are not financially prepared to care for you or your family in the event of a disability. It is time to take responsibility for your finances, and insurance falls squarely within that box. Don’t jeopardize your parents’ retirement savings with your unwillingness to protect the very income you’ve worked so hard to earn.
Excuse: It’s too expensive.
Reality: On average, it takes about 2 percent of your gross income to protect the industry maximum allowed, which is somewhere around 70 percent of your gross income. Remember, gross income is before taxes are taken out.
Excuse: I don’t know where to obtain it, or I don’t understand the process.
Reality: Use this guide as a starting place. You can reach out to human resources to find out what you currently have and what additional options may be available through your employer, and reach out to a CFP® to help you fill the gap.
Advisory services offered through Investment Advisors, a division of ProEquities Inc., A Registered Investment Advisor. Securities offered through ProEquities, Inc., a Registered Broker-Dealer, Member FINRA & SIPC. Stable Waters Financial is independent of ProEquities, Inc.
Katie Waters is a member of the DailyWorth Connect Program. Read more about the program here.