The Surgeon Who Lost His FingersFeb 13, 2020
by Jonathan G. Cameron, CFP®
Nobody plans for a disability. In our experience, people are more willing to incorporate life insurance into their financial plan than disability insurance. Why is this? Let’s first get into the differences between disability and life insurance.
Disability Insurance vs. Life Insurance
Here are a few key differences between these two types of insurance:
- With a life insurance a policy claim, your insurance company pays others at your death. A disability income claim pays you, maintaining your family’s financial well-being during an illness or injury.
- Death is a certainty, so your beneficiaries will get paid the life insurance death benefit. A disability benefit pays only when you have a covered injury or illness, insuring against the loss of earned income.
- Traditionally, a life insurance death benefit pays beneficiaries in a lump sum. A disability policy typically pays a monthly income to the policyholder up until age 65.
- Many life insurance policies now offer chronic or terminal illness riders, allowing policy owners to draw down part of the death benefit while alive. Many disability policies provide riders that offer a lump sum payment in addition to the monthly income benefit when ill or injured.
- In the private marketplace, both life and disability insurance policies typically provide tax-free benefits.
- Obtaining life insurance involves an application and a health screening exam. Obtaining disability insurance involves that, plus verification of earned income.
Disability Insurance Prevents Financial Devastation to Families
A long-term disability is often more financially devastating to a family than a death. Statistically speaking, the younger you are the more likely you are to suffer from a major injury or illness during your life.
Disability Insurance Definition of Your “Own” Occupation
One of the most important things to understand about disability insurance is that you can receive an income benefit due to an injury or illness, but still continue to work and earn an income. This is possible when the definition of disability is that you can no longer perform your “own” or “regular” occupation. Let me illustrate:
Imagine you are a surgeon who loses a couple of fingers in a freak accident. You may no longer be able to do your job in the operating room. Perhaps you are a civil engineer who contracts a debilitating disease that prevents you from working on a construction site. Both of these scenarios may prevent you from performing your “own” occupation, though you may still be able to work in your field in another capacity. Or you decide to go into a different field. The point is, you may be able to double dip here – if you’re that surgeon who lost some digits, you can join a private practice and still receive disability income. The disability definitions are crucial.
“Own” vs. “Any” Occupation in Disability Insurance Contracts
Besides an “own” occupation policy, another definition for disability is “any” occupation. This definition is less strong. An “any” occupation policy pays when you can no longer perform the functions and duties of the occupation for which you are suited by reason of education, training, and experience. Continuing with the surgeon example, a policy likely won’t pay if the surgeon moves to a private practice. It may pay a benefit if he goes into an unrelated field.
Who Should Buy Disability Coverage?
The answer: Anyone with an expensive education. What you are insuring is your ability to earn a living. The reasoning is similar to why you should own a life insurance policy: someone else is depending upon you for a living. However, as we’ve discussed, an injury or illness is much more likely than an untimely death.
Strong Case for a Disability Policy for a Young Professional
Disability insurance is especially important for professionals who recently completed an expensive education. Physicians and Attorneys come to mind. Perhaps you worked for a few years out of medical school, or you’re out of residency, and you’re beginning to realize a return on your investment. You have a lot of debt. Your biggest asset now is your education – this is your ticket to earning your living. An injury or illness at this point would be financially and emotionally devastating for you and your family. This is why you buy a disability policy. You insure your other large assets - your life, your car, and your health. Doesn't it make sense to insure your living?
Riders to consider adding to a new disability insurance policy
Purchasing a disability insurance policy comes with the option to include “riders”. Riders are add-ons to disability insurance policies which often times make a policy stronger. There are a few important rider choices to make before purchasing a disability policy:
This rider pays if you’re partially disabled and work part-time.
Cost-of-Living Adjustment (COLA)
Adding COLA to your disability insurance policy takes into account future inflation.
Guaranteed Insurability Option
This add-on allows for benefit increases through the years with only financial underwriting – not physical.
Disability Insurance Only Covers a Portion of Lost Income
Please note that policies will cover only about 50% to 60% of your income. You may get a higher amount if you are a new professional beginning work and can submit a contract of employment. Note: riders cannot be added after policy placement.
What are the Tax Consequences?
Consequently if the benefit is taxable, the income replacement ratio is even smaller. Generally, if you own a policy on yourself, and do not deduct the premium as a business expense, the benefit will be tax free. This is unlike group plans, where the employer will deduct the premium, rendering the benefit fully taxable to the employee.
Get in Touch!
Check out Jonathan's piece on The Difference between Disability Insurance and Long Term Care. Questions? Feel free to get in touch with us at [email protected] Also follow us LinkedIn, Facebook, Instagram, and YouTube for more personal financial information relevant to you!
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