Why Disability Insurance Is Critical

Most people understand why having life insurance is a good idea: Nobody wants to leave their survivors in a financial lurch if they were to die suddenly. But what if you suffer an accident or illness and don't die, but rather, become severely disabled? Could you or your family make ends meet without your paycheck, possibly for decades?

Although most people are entitled to Social Security disability insurance (SSDI) benefits if they've paid sufficient FICA payroll taxes over the years, the eligibility rules are extremely strict, applying can take many months, and the average monthly benefit is only about $1,150.

So what are your other disability coverage options? Many companies provide sick leave and short-term disability coverage to reimburse employees during brief periods of illness or injury. Some also provide long-term disability (LTD) insurance that replaces a percentage of pay for an extended period of time.

But employer-provided LTD plans usually replace only about 60 percent of pay and the money you receive is considered taxable income, further lowering your benefit's worth. Plus, such plans often have a waiting period before benefits kick in, will carve out any SSDI benefits you receive, and cap the monthly benefit amount and maximum payout period (often as little as two years).

Thus, even if your employer provides basic LTD, you might want to purchase additional coverage. Just be prepared: LTD insurance can be expensive. Yearly premiums may cost 1 to 3 percent of gross income, depending on plan features, your age, and whether you have preexisting conditions.

First, see if you can buy supplemental coverage through your employer's plan – their group rate will be cheaper than an individual policy and you probably won't need a physical exam. Or see if any professional or trade organizations you belong to offer group coverage.

If not, you'll have to buy an individual policy. A few of the things to keep in mind:

• The younger and healthier you are, the lower the premiums you'll be able to lock in.
• Some policies won't pay benefits unless you can't perform the duties of your own occupation, while others specify that you must be physically unable to perform any job (the latter coverage is much cheaper).
• Look for a "non-cancelable" policy, which means the insurer can't cancel or refuse to renew your policy – or raise the premium – if you pay on time.
• The longer the waiting period before benefits are paid, the lower the premium. Thus, if you have enough sick time and savings to wait 120 days before payout, your premiums will be significantly less than for a 60-day waiting period.
• Some policies only provide benefits for two years, while others pay until your normal Social Security retirement age – most cover somewhere in between. The shorter the term, the lower the cost.
• Many plans exclude preexisting conditions, mental health or substance abuse issues.
• For an additional fee, policies with a "future purchase option" allow you to increase coverage as your wages rise, without having to take another physical or rewrite the policy.
• Check whether the benefit payout amount is fixed or if cost-of-living adjustments are made periodically. The latter type is more expensive but offers better protection against inflation if you're disabled for many years.

Bottom line: If you became seriously disabled it could easily wipe out your savings and put your family in financial jeopardy. Before you actually need it, investigate what disability coverage you already have and what other options are available.