I enjoy tax season for many reasons, but most of all because I look forward to catching up with so many of you and hearing how your year went. It also gives me insight into the local economy and how people are being affected (still struggling by the way). A common thread this year was stories of families hit with injuries or illnesses that lasted for months. Those are the kinds of events that can wreak havoc on your finances and underscore the need for strong emergency planning, including disability insurance.
Most people recognize the need for life insurance, but the need for disability coverage is often overlooked. The fact is though, that statistically you are more likely to become disabled than die before age 65. How likely is a disability in your case? You can check out this calculator at www.whatsmypdq.org to input some general characteristics and get a customized estimate. My chance of being disabled for at least three months was 24% with an average length of disability for someone like me of 84 months. Yikes.
There are a few different ways to cover the financial impacts of becoming disabled. One option, and one many choose by default, is to self-insure; meaning you’ll just do without your income and cover your bills with personal savings. Not a great plan unless you have a very large emergency stash that you won’t need for retirement or anything else. A more effective way to cover yourself is through disability insurance, which you can obtain through an employee benefit, by purchasing it yourself, or a combination of the two.
When looking at disability coverage, there are two parts: short term coverage and long term coverage. For short term disabilities or illnesses, typically 26 weeks or less, your employer may cover part or all with sick days or other short term coverage. New Jersey and New York mandate private employers to either participate in the state plan or provide other insurance to cover non-work related illnesses or injuries for up to 26 weeks. These benefits only cover a portion of salary for eligible workers: 50% of normal salary, capped at $170 per week for New York; and 2/3 of salary, capped at $572 for New Jersey employment. Pennsylvania residents who participate in these plans through their employers are eligible, but Pennsylvania workers are not covered by any state plan. That can leave you stuck if you use up all of your sick and vacation days and your employer does not offer additional benefits. Short term policies are available for purchase privately to help close the gap.
Once those short term benefits, if any, are exhausted, your long term disability policy kicks in. Employers will sometimes offer a base policy (50% of your pay for example) paid by the company, with the option to buy optional coverage (perhaps an additional 10% of pay) out of pocket. You may find that no medical questions are asked if you choose optional coverage when first offered, but should you choose to enroll later you will be subject to medical underwriting. You may also be offered the choice to pay premiums before tax or after tax. When paying the premium with pre-tax dollars, you have the benefit of the tax savings but if and when you collect benefits, they will be taxable as income. On the other hand, if you choose to pay the premiums out of your after tax net pay, should you receive benefits they will be tax free, which makes the dollars go further. When you are replacing only a portion of your income, that feature is an important benefit booster.
What if your employer doesn’t offer any options for disability benefits or the benefits aren’t enough? Long term disability products are offered for sale privately as well. The premiums for policies are rated according to your age, health, occupation, and earnings to be replaced. Premiums are also dependent upon the options you choose, such as your elimination period (the number of days that must go by before the coverage begins), the length of time your disability will be covered (two years for instance will be less expensive than policies that cover until age 65), any inflation protection, and the conditions for you to return to work. Some policies will only cover your disability until you can return to work at any job, regardless of whether that is the occupation you were working in prior to your illness or injury, while others will continue coverage until you can return to your own occupation. These “own-occupation” policies are more expensive because of their generous coverage. You may also find policies that are hybrids of these two; they may cover your inability to return to your own occupation for two years for example, but then stop coverage if you are able to work in another field. Carefully inspect all definitions prior to purchasing a policy.
A business owner is particularly vulnerable during times of disability, as he not only loses income, but if he is the primary generator of business income, the business suffers while bills continue to pile up. In addition to regular disability insurance, business overhead insurance can help to cover the cost of keeping the business going while the owner is unable to work.
Disability insurance is an important part of the financial emergency plan to cover the loss of a breadwinner’s income. But what happens if the disability is not yours, but your child’s? What if you have to leave work for an extended period of time to be with an ailing parent in another city? These are the kinds of life events we think will never happen to us, but they do. If you’ve been putting off getting that emergency fund going, start today. You can’t build it up overnight, but a dollar saved today is better than having none tomorrow. In the meantime, what you can take care of now is putting a plan together to tend to your personal and business affairs in the event of a family emergency. If you had to leave home for weeks, how would your bills get paid? Who would take care of your pets? Does someone have a key to your house, your mailbox? Think of the things you do in the normal course of life. Make a detailed list and share it with someone you trust who could step into your shoes and keep your home running in your absence. You may think you can take care of things remotely, and perhaps you can, but chances are if you are dealing with a traumatic event you won’t want to. If you own a business with clients and employees depending on you, do you have an emergency plan? Especially if you work alone, enlist someone you trust to learn at least the basics to either service your clients until you can return or act as a liaison with another professional who can help out. Get all of those little details that are tucked away inside your head out on paper so someone else can help should disaster strike. The time to think about the unthinkable is now.