Disability insurance: Are you really protected?
PEGGY VYBORNY, CPA
Your ability to earn an income is one of your greatest assets. A disability that prevented you from working would be devastating to your financial well-being. Disability insurance can help protect this asset, but not all policies are created equal.
To determine whether a disability policy provides the protection you need, ask the following questions:
What Does it Cover?
Basic disability policies replace a portion — typically 45% to 65% — of your current monthly gross income. But, this figure can be deceiving. The portion of your income it replaces depends in part on whether the benefits are taxed. Generally, if you pay the premiums on an individual policy, benefits are tax-free. However, if you are covered by an employer-paid group plan not taxed to you as compensation, benefits are taxable.
Most basic policies impose limits ranging from $10,000 to $15,000 on monthly benefits. For example, suppose an individual has a monthly gross income of $25,000 and a disability policy that replaces 65% of that amount. If there’s a $10,000 cap on monthly benefits, then the policy covers only 40% of that person’s income.
Higher-end policies cover as much as 75% of income and offer substantially higher monthly limits. Additionally, some policies pay a lump sum at the end of the benefit period.
How Does the Policy Define Disability?
How an insurer defines disability greatly affects your ability to collect benefits. The most generous policies define total disability as the inability to perform the “material and substantial duties” of your own occupation. That means you would receive full benefits even if you find a job in a different occupation, regardless of how much you earn. So, for example, a surgeon who develops a tremor in her hands and can no longer operate might receive full disability benefits, even if she switches to a different medical specialty and earns as much or more than before.
Other definitions may include:
- Modified Own Occupation
Disability is based on an inability to perform your own occupation. But, if you find gainful employment in another occupation, benefits are cut back or eliminated;
- Transitional Own Occupation
Benefits are reduced once your total income (including disability benefits and earnings from another occupation) surpasses your pre-disability income; and
- Any Occupation
You receive benefits only if you are unable to perform the material and substantial duties of any occupation. Typically, this is a more difficult threshold to meet.
Note that some policies apply an “own occupation” standard for a specified period, such as 18 months or two years, and then switch to a different standard.
Is partial disability covered?
A partial disability can have a significant impact on your ability to work. For example, you might be able to perform your own occupation, but not full time. Some policies offer partial disability benefits, such as a 50% benefit if a disability causes your income to decline by 20% or more, and a 100% benefit if your loss is 80% or higher.
What about benefit and elimination periods?
The benefit period can vary dramatically from policy to policy. Some policies pay benefits for as little as one or two years, while others pay benefits until age 65 or longer. The elimination period is the amount of time — usually 30, 60 or 90 days — you must wait after becoming disabled before benefits begin.
Bridge the gaps
To determine your level of protection under a disability policy, review its terms and calculate the gap between your current income and the benefits you would receive if you became disabled. If the gap is large, consider purchasing supplemental or replacement coverage.
How to transition into a comfortable retirement
You have worked hard, saved and planned for decades, and now retirement is just on the horizon. This can be a happy time in your life, but at the same time, be a little bit scary. Throughout my career, I have seen people handle this time very differently. As retirement approaches, there are several steps that you should take to make this transition as smooth as possible.
Develop an action plan now. The following suggestions are items that you should do before your retire:
Build an Emergency Fund
If you have not already started a fund, you need to put aside at least enough to cover two or three months of living expenses. This can be done at any stage in your life, but it is very important to do this before you retire because there may be a lag time after you leave your job and before you start to receive your pension, Social Security or other payments. Timing is everything.
Pay down debt
You will need to reduce your credit card debt and accelerate your mortgage payments. The less debt you have at retirement, the more manageable and less stressful your life will be.
Create a budget
Carefully analyze your expected retirement expenses and make adjustments to your preliminary budget. Develop a budget that is realistic, as this is the best way to minimize the chances that you will outlive your savings.
Adjust your asset allocation
It is a good idea to review your asset allocation. Work with your financial advisor to make adjustments that reflect your changing circumstances, time horizon and risk tolerance.
Review health insurance options
Since health care will likely be a major expense as you get older, this is one expense that will most likely keep going up. Once you reach age 65, Medicare will cover most of your routine expenses, but you will probably need supplemental coverage for non-routine expenses.
Have a Social Security plan
You have a great deal of flexibility on when you can begin receiving Social Security benefits. You can start as early as age 62, or as late as age 70. Timing may affect your financial plan. The later you opt to begin receiving benefits, the greater your monthly benefit will be. Therefore, it is generally best to wait as long as you can.
It is better to start working on the transition several years before your planned retirement date. The sooner you begin, the more time you have to make adjustments to your plan. If you do get a late start or are forced to retire before you planned, then it might be a good idea to get a financial planning expert to help you get on track with your retirement plan.
Develop a retirement income timeline
Determine the timing of your retirement income and sources from which you will receive it. Also, be sure to factor in your retirement expenses. If you have a traditional IRA or other retirement accounts, you will need to take required minimum distributions (RMDs) from these accounts starting in the year you reach age 70-½. These distributions are required whether you need the money or not, and you will be penalized if you do not take them. If you estimate that RMDs will not cover your expenses, you will need to look at other sources of income. A good rule of thumb is to take money from the following accounts in the following order.
- Taxable investment accounts;
- Tax-deferred accounts, such as traditional IRAs or 401(k) accounts; and
- Tax-free accounts, such as Roth IRAs or Roth 401(k) accounts.
Withdrawals from taxable accounts generate capital gains, which are taxed at a lower rate. This plan allows the tax advantage accounts to grow as long as possible. Finally, be careful when withdrawing funds, so that you do not get into the principal too early. If you start using up your principal, you may not have enough money to last you through retirement.
Related read: “For Good Financial Health, Take Your RMDs“