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Disability Insurance: What You Need to Know

In a previous post, we discussed life insurance, which is essentially a way to transfer financial risk to an insurance company to protect people who financially depend on you. For example, life insurance protects your dependents in the event of your premature or accidental death. Another type of insurance is disability insurance. Disability insurance protects you and your dependents in case you can no longer earn an income.

Before discussing disability insurance, I want to cover an important point. I do not sell insurance. Since I do not offer insurance, I can advise on insurance options as part of a discussion on financial planning without endorsing a particular product.

Becoming disabled is more common than you might think

While no one likes to think about being disabled, it is important to consider the possibility that it may happen at some point, and you want to protect your standard of living. Not everyone needs life insurance, but every working adult needs disability insurance.

Disability insurance is insurance for your income. Your income pays your bills, provides savings, and helps you build your future wealth. Disability insurance protects your ability to have the potential to be financially independent and build wealth.

According to the Council on Disability Awareness, approximately one-fourth of today’s 20-year-olds will become disabled at some point before they retire. Most long-term disabilities are secondary to back injuries, cancer, and heart disease, not accidents. The average long-term disability claim is about 34.6 months.

What is a disability?

The definition of a disability can vary by organization. Therefore, your employer or insurance provider should define a qualifying disability. Since not everyone’s definition of a disability that could keep them from working is the same, understanding what qualifies as a disability is an important first step to determining what kind of coverage you might need.

Short-term and long-term disability insurance

Short-term disability insurance

According to the Society for Human Resource Management, SHRM, short-term disability insurance replaces all or part of lost income because of a temporary disability. Short-term disability plans generally have a short waiting period before coverage begins. Employee paid time off is expected to cover this gap. Short-term disability benefits typically cover 60 to 75 percent of an employee’s base pay. The median length of short-term disability is 26 weeks.

Long-term disability insurance

Many employers offer long-term disability that starts where short-term plans leave off. Long-term disability insurance may cover an employee until retirement age, or it may have a shorter cap, such as two to three years of coverage.

Long-term disability insurance does not kick in right away. Instead, there is usually a waiting period, called an elimination period, that must elapse before you can receive benefits. The length of this waiting period varies but is typically around three months.

In many cases, employer-provided disability insurance only covers you as long as you work for the company. There may also be a cap on the amount of insurance they offer.


If you are self-employed or your employer does not offer disability insurance or not enough disability insurance, then you might choose to self-insure.

Short-term disability insurance

You might find that you do not need short-term disability insurance because you are confident that you have the cash reserves necessary to cover three to six months of income. Having enough funds to cover your income for the short term saves you the cost of short-term disability insurance without worrying about whether you have enough money to pay your bills if you cannot work.

Long-term disability insurance

Long-term disability is different. It should protect your income until you reach retirement age, especially if you and your loved ones depend on that income. However, long-term plans have a longer waiting period before the coverage starts than do short-term plans, so it is still important to build up a reserve to maintain cash flows while you are unable to work.

According to SHRM, long-term disability insurance typically covers 60 to 75 percent of your base pay. As a result, insurance companies strike a balance between your need to replace your income if you become disabled and not providing an incentive to become disabled by fully replacing your income.

It’s challenging to determine how much insurance to purchase. On the one hand, you do not want to over-purchase insurance and pay premiums beyond what is necessary to cover your expenses. But, you want to ensure your income is protected if you unexpectedly become disabled. Working with a financial adviser can help you sort through your options.

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