Disability Insurance and How It Works
Disability insurance works as an agreement between insurance companies and you, the policyholder. If you lose your ability to work and earn a paycheck due to a disability, your insurance provider is able to replace a percentage of the income you have lost. Having disability income insurance means being able to meet your financial obligations.
How does disability insurance work? What are its benefits?
First and foremost, it's important to define what constitutes a disability as well as keeping in mind that this definition can vary depending on the different types of benefits.
Some definitions may mirror the Americans with Disabilities Act (ADA) definition which indicates that "an individual is considered to have a 'disability' if he or she has a physical or mental impairment that substantially limits one or more major life activity, has a record of such an impairment, or is regarded as having such an impairment."
Pregnancy or childbirth, for example, are not typically covered disabilities under the ADA. Some benefits, however, have more simple definitions and can cover any medical conditions in which an employee receives treatment by a health care provider or is incapacitated for a certain period of time.
Disability insurance comes in two forms: long-term and short-term. Short-term disability insurance covers you immediately following a severe illness or injury and makes up for lost income for six months or less. Long-term disability insurances have an elimination period of at least 90 days and are intended to maintain income replacement for the long haul after that. If your condition keeps you out of work past the end of your short-term disability coverage span, you might want to seek long-term disability insurance. The benefit paid to you by either form of disability insurance can cover things like basic living expenses, including groceries, utilities, school tuition, home, and car payments, and can even contribute to your savings.
Whether long-term or short-term, a disability insurance policy has five key features. Keep in mind that these features do vary from policy to policy:
A premium amount is the amount you (or your employer) pay for the policy. Premiums are determined by the duration and form of coverage you choose, as well as your health status, benefit amount, and other factors.
A benefit amount is the amount you collect per month if you are unable to work due to a severe disability and typically ranges from 60% to 80% of your monthly income. The benefit amount is normally not taxed if you choose an individual plan (unless paid for with pre-tax dollars). The benefit would be taxable if it's a group plan paid in part by your employer.
The length of time you receive benefits is called a benefit period. Benefit periods of short-term disability plans can last up to a year, while the benefit periods of long-term disability plans can last up to two years, or until you recover from your illness or accident.
Also referred to as an elimination period, a waiting period is the amount of time that passes after you are disabled until you start receiving benefits. The time is typically shorter for short-term disability policies than it is for long-term disability policies.
Definition of Disability
Defining disability and what it means to be "disabled" varies among disability policies and affects a policyholder's benefits. An own-occupation definition means you qualify if, due to disability, you can't work in your occupation, including any specialty. Any-occupation means that if you become disabled but could still perform a less demanding job, you may not get the benefit. Defining different levels of disability, like "partial disability", can also qualify you for various percentages of your total benefit amount.
It is important to note that long-term disability insurance plans can be tailored to your specific needs and are therefore a better option as opposed to short-term disability insurances.
If an individual disability insurance policy is additionally selected, more flexibility and additional options may be offered. This type of policy stays in place no matter what decisions you make in your life regarding your job/career, and you can choose the period of time you want coverage in place. Looking into the quality of the disability income insurance you are interested in is important, so make sure to ask specific questions in order to help you better understand and better evaluate the benefits offered.
What does disability insurance cover?
Disability income insurance covers everything from total to partial disability to disability of such a severe extent that the insurance company presumes you won't recover from it.
While many insurances like homeowner's insurance or auto insurance are typically straightforward, disability insurance isn't. It doesn't actually "cover" disabilities. Instead, it covers a portion of your income in the event of a disability. So, it's best to look at it from a general income insurance perspective and not a disability one. That's why at Asteya we prefer to call it disability income insurance or simply income insurance. It acts like a monthly paycheck when injury or illness hits and renders you unable to work.
People underestimate the risk of becoming disabled. It is, in reality, greater than we think. According to the Social Security Administration, one in four workers will become disabled during their working years, and one in eight will experience a long-term disability that lasts more than five years. Disability insurance also isn't just for freak accidents: almost 90% of long-term disabilities are caused by illnesses such as cancer, mental nervous, heart disease, and even arthritis.
Is disability insurance taxable?
No matter how much you spend on income insurance, it's important to understand the tax treatment of individual coverage. The monthly income insurance premiums that you pay for to have a personal policy are not tax-deductible. However, you will not pay income tax on benefits from a disability policy where you paid the premiums with after-tax dollars. We recommend that you consult with your tax professional.
Generally, if your employer paid the premiums, then the disability income is taxable to you. We do advise you to select an after-tax disability insurance policy if one is available through your employer.
See our income insurance pricing here.