What is Disability Insurance and How Does It Work?

Disability insurance provides coverage to help you replace your income if you can't work due to illness, injury, or other medical condition (like pregnancy). Typically, it pays a percentage of your base salary. It usually kicks in after sick pay, vacation, family leave, and any other paid leaves run out.

There are two main types of disability insurance: short-term and long-term.

Short-term disability (STD) policies provide partial income replacement for a temporary period of time. The benefit amount can potentially cover up to 100% of your income and typically lasts for 3-6 months (specific amounts and time lengths will vary by policy).

Additionally, there may be a waiting period (also known as elimination period) before the benefits kick in. This will also vary by policy but is typically less than two weeks.

Long-term disability (LTD) insurance provides partial income replacement for an extended period of time. The benefit amount is typically 50-70% of your income and can last up to ten years or even until retirement age, depending on your specific policy. The typical elimination period for an LTD policy can range from 3-6 months or when short-term disability insurance ends (this will vary by policy).

There are a few ways to get disability insurance: through your employer, privately, or through a government program.

Many employers offer group short-term and long-term disability insurance policies as part of their benefits package to employees. These policies often come at a lower cost because the employer may subsidize a portion of the premium and make it easier for individuals with medical conditions to obtain coverage. However, most policies typically replace 40%-60% of your gross base salary (the full amount your employer pays you, before taxes and other deductions are taken out). Work bonuses or commission-based income may not be covered.

If you make a very high salary, there may be an annual limit on how much your policy will pay. If you're in that category or if you rely on commissions or bonuses for the bulk of your income, consider looking into additional coverage through a private insurance company.

Private disability insurance can be purchased directly from insurance companies, through an insurance licensed agent or broker, or through a professional association. This can make sense if your employer doesn't offer disability insurance, you're self-employed, a small business owner, or you need additional disability insurance beyond what your employer can provide.

Private disability insurance policies tend to offer more customization than employer-provided disability insurance plans, including the ability to choose a longer benefit period, higher coverage limits, and a more favorable definition of disability that allows you to potentially do some work outside your own occupation. However, private policies typically require medical underwriting, meaning your premiums and eligibility will depend on your health history, age, and occupation.

Before purchasing a private policy, compare your options carefully. Make sure to understand:

• The policy's definition of disability, elimination period, and benefit period.
• Whether the policy includes cost-of-living adjustments to keep up with inflation.
• If it is non-cancellable and guaranteed renewable to ensure future coverage stability (meaning the insurance company can't cancel your policy, can't raise your premiums, and guarantees your ability to renew your policy as long as you continue to pay for it).

Since private disability insurance is an individual policy, premiums are typically higher than employer-sponsored options. However, it can offer greater security because coverage can remain intact even if you change jobs.

Government programs that provide disability insurance include Social Security Disability Insurance (SSDI), state-funded disability programs, and Veteran's Affairs disability insurance.

Many government programs do have specific requirements and eligibility criteria. For example, SSDI supports those who can't do any work due to significant long-term disabilities. SSDI eligibility depends on your employment history and income, reflecting the Social Security taxes you've paid. The average SSDI benefit for disabled workers is around $1,580 per month, according to the Social Security Administration.

To qualify for SSDI, the disability must be expected to last greater than 12 months. SSDI doesn't pay for partial disability or short-term disability. Additionally, there is a five-month waiting period before benefits begin.

If you have a long-term group disability and also receive SSDI, your benefit may likely be offset by SSDI, meaning that your income benefits do not stack–SSDI may offset the income benefit you receive from your long-term disability policy. (Check your specific policy to confirm).

For additional information on SSDI, and eligibility requirements, visit the official website of the Social Security Administration: https://www.ssa.gov/.

If you paid for disability insurance premiums with pre-tax dollars, the income benefit will likely be taxable. On the other hand, if you paid premiums with after-tax dollars, the income benefit will not likely be taxed.

For government programs, SSDI may be taxable depending on your combined income. State-funded disability benefits may be taxable depending on your state, and VA disability benefits are not taxable.

Rachel, a 40-year-old marketing professional, has a serious back injury from a recent ski trip that requires surgery and months of rehabilitation. Here's how her disability insurance benefits could work:

• Short-term disability insurance: After using her paid time off, Rachel's short-term disability policy kicks in, providing a monthly benefit that replaces 60% of her base salary for five months while she recovers and undergoes physical therapy.
• Long-term disability insurance: Unfortunately, Rachel's recovery takes longer than expected, and she can't return to work when her short-term disability benefits end. At this point, her long-term disability kicks in and covers 60% of her base salary. These long-term disability benefits continue until she can work again or until she reaches the benefit period limit specified in her policy.
• Private disability insurance: Since Rachel's employer-provided policy effectively replaces 50% of her total income, she also purchased a supplemental private disability policy to help ensure she can manage her mortgage and other expenses during her recovery.
• Government support: If after the injury, Rachel is permanently disabled and can no longer work, she can apply for SSDI and will need to wait at least five months before she starts to receive SSDI benefits. After 24 months on SSDI, she would become eligible for Medicare.

The loss of income due to injury or illness can pose a serious setback to any life and financial goal, but disability insurance can effectively help protect your finances and standard of living. Review your group policy to understand your disability coverage or consult with a qualified insurance professional or financial advisor to review your options.