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Individual disability insurance (DI) safeguards a person’s wages when a non-work-related illness or injury prevents them from working for a certain period of time. But this type of insurance (and the peace of mind it provides) is sometimes “lost in the shuffle” when planning for unexpected life events and the costs that come with them. For example, while many people buy insurance to protect their cars, homes, and health without batting an eye, income protection is often overlooked.
There’s no single reason why. For example, many workers believe that experiencing a disability is something that only older generations face, when in fact, data from the Social Security Administration shows that one in every four 20-year-olds experiences a disability before reaching retirement age. Moreover, some think workers’ compensation will protect their paychecks if they are disabled outside of work, when in fact, it only covers on-the-job incidents. And with so many providers on the market, finding one that meets your needs can take longer than finding a needle in a haystack.
To help you understand the ins and outs of individual disability income insurance, we’ll go over the wage protection it provides, who usually buys these policies, and some insights from OnPay’s Vice President of Insurance, Paul Foery, so you can make an informed decision when looking for a provider.
Individual disability insurance (DI) safeguards income
To start, an individual disability insurance income policy, also known as personal disability coverage, provides a portion of income replacement for people who are unable to earn a paycheck due to life events such as sickness or injury occurring outside of work. It is important to understand that the amount of income is calculated based on a percentage of the person’s total income, which means that the policyholder receives a portion of their wages (policies are not designed to cover lost income in full).
Having an individual disability income policy arguably protects your most important asset: the ability to earn a paycheck and cover your living expenses. “The number one asset that protects all the assets you count on is income,” explains Paul Foery, OnPay’s former Vice President of Insurance and licensed insurance professional who has over 30 years of assisting small businesses with plans. “If you can’t work, and earn a paycheck, all of the essentials and things you count on, and spend money on, from day-to-day have the potential to go away.”
Let’s talk about who this type of insurance protects now that we’ve established what it’s for.
“The number one asset that protects all the assets you count on is income. If you can’t work, and earn a paycheck, all of the essentials and things you count on, and spend money on, from day-to-day have the potential to go away.”
— Paul Foery, OnPay's Vice President of Insurance
Covering your bases: Who does individual disability income protect
Simply put, as the policyholder, policy owner, or key executive receiving coverage, you’ll be eligible for partial income replacement if you’re unable to perform your job duties due to illness or injury that happens outside of work. In fact, these plans are designed to help if earning an income is not possible for an extended period of time, usually lasting up to SSNRA (social security normal retirement age).
The purpose is to provide a steady source of income so you can focus on your health, family, and obligations without having to worry about where your next paycheck is coming from. By extension, members of your household also benefit because any wages you receive can be used toward essentials such as:
- food and utilities
- home repairs
- mortgage or rent payments
- school tuition
- or whatever living expenses you have (or choose to put funds toward)
Next, let’s cover some basics around group vs disability insurance for employers and employees.
How do group and individual disability insurance differ?
Though they share some similarities, there are some differences to keep in mind.
Group plans
- Most employers offer group short-term and long-term disability insurance benefits to their employees.
- Group plans generally cover all full-time employees regardless of age, position within the company, or health history. In many cases, workers can enroll with a few clicks of their mouse during their new hire onboarding without having to take a physical exam or undergo any form of underwriting.
- If an employee enrolls and leaves for a job with another company (or for any reason such as retirement or quitting), coverage will not follow them to their new employer.
Individual plans
- Because carriers thoroughly review applications before providing a final quote, a person interested in purchasing individual disability insurance coverage may need to jump through a few more hoops.
- Carriers require applicants to prove what their wages are, which means submitting a 1040 (also known as your individual US income tax return) for verifying income.
- More stringent eligibility and medical underwriting requirements for the applicant, including a physical exam.
- Plans also cost more because they are underwritten, but the benefits generally offer more protection for the policyholder.
- The individual who buys the policy is the owner as long as they pay the premium
- Applications can be many pages long; asking about job history, medical history, and other factors; there’s a lot more substantiation.
One of the most significant differences between group and individual coverage is the application process. Again we spoke with Foery for insights into what the process of applying for individual coverage looks like.
“As part of the underwriting process, carriers will ask you to send your W-2 for the last two to three years to verify what your wages are; they won’t just take your word for it,” he says. “Remember that anyone can say they earn $50,000 in salary and $50,000 in commissions, and a carrier is likely willing to pay it out — but they will require proof of income.”
Let’s talk more about who generally takes a closer look at the income replacement that individual disability insurance provides.
Who buys individual disability income insurance to protect wages?
Many different professionals purchase disability insurance, from business owners and executives to a company that wants to protect a key employee. Generally, DI can be beneficial for anyone who’s unsure they’ll be able to make ends meet should an unforeseen event prevent them from earning a paycheck. Even if an employee is on an existing group plan through their employer, purchasing additional coverage in the form of individual disability insurance is an option they can take advantage of.
If you’re on the fence about whether this type of coverage is worth the investment, it might be helpful to consider a few questions:
- Is there another wage earner in your household if a life-changing event prevents you from working and earning money?
- Are your finances in good enough shape as the sole provider of income to cover recurring expenses if you are unable to work for an extended period of time?
- You may have health insurance, but do you have an income policy to pay the bills that health insurance may not cover? Things such as a babysitter when you go to the doctor or covering the cost of a child’s soccer league.
We’ve discussed who and what policies cover, so let’s talk more about the approximate amount of wage protection it provides.
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How much paycheck protection does individual disability insurance actually provide?
An individual (personal) disability plan typically replaces income in the range of 50% to 70% of a policyholder’s income, if events such as illness or injury prevent a person from earning wages. This could be tax-free, depending on who is paying the premium.
- If the company is paying the premium, it is taxable
- If the individual is paying the premium, it is tax-free
Do individual disability insurance policies have a waiting period?
Most — if not all — disability income insurance coverage has a waiting period the policy owner must satisfy before benefits are paid out. What does this mean? The policyholder needs to experience the disability for a certain period of time before making a claim to replace income. Depending on the policy, the waiting period ranges from 30 to 180 days.
Features of individual disability insurance coverage
While this has much to do with the carrier you choose (and how much you want to customize a policy), there are different features that you could add to your policy.
- You could potentially have a higher portion of income replacement if you add an optional rider to account for things such as cost of living adjustments (COLA), residual disability benefits, and future increase options. So if you’re disabled at age 40, you take on a rider that sets you up for 3% a year or 5% increase per year.
- Non-cancellable and guaranteed renewable policies.
- Benefits that are generally tax-free if premiums are paid with after-tax dollars.
Is individual disability insurance worth the investment?
This depends on an individual’s budget and the amount of savings on hand, and what they can afford to dip into for living expenses. Though it depends on the insurance company (and many different variables), policies can cost upwards of $2,000 – $4,000 annually for a premium. As income replacement, the money alone could make the difference, especially if you experience a life event that prevents you from performing your job for an extended period.
Costs can also fluctuate on how quickly you need income replacement. Once more, we spoke with Foery for his take. “How much money can you get to bridge the gap? The shorter your waiting period the most costly your premium is going to be,” he explains. “But if you’re able to keep up with expenses for 30 to 180 days, it is going to lower your premium for the policy.”
“How much money can you get to bridge the gap? The shorter your waiting period the most costly your premium is going to be. But if you’re able to keep up with expenses for 30 to 180 days, it is going to lower your premium for the policy.”
— Paul Foery, Former Vice President of Insurance at OnPay
To see what income replacement could look like, let’s look at an example.
- Fred earns an income of $80,000 per year and decides to purchase coverage in the event a disability prevents him from being able to work. His contract is written with his insurance company, which will pay 60% of his $80,000 salary (per year) in the event he becomes disabled up until the age of 65.
- That equals $48,000 per year. Let’s say Fred experiences a disability at age 40 and is unable to work until retirement age. That means the carrier ends up paying out $48,000 per year for 25 years (since Fred worked with his broker to write a policy that takes him through age 65).
- Since his disability occurs at age 40, he would receive $48,000 per year, for the next 25 years, which equals $1,200,000 million dollars.
Again, each person’s situation (and policy) is different. The takeaway is that investing in a policy could make an enormous difference in terms of covering living expenses should a claim need to be made.
Keep benefits in balance
Many employers know that providing perks like disability insurance can boost recruiting and retention efforts. But effectively managing employee benefits plans can be complex, so how do you keep track of everything? Most businesses will use an employee benefits system to make sure that employees receive what they are entitled to, streamline payroll deductions, and communicate plan changes.
Shopping for an insurance policy
When doing your research, remember plans can be customized, and there are many factors to consider. Once more, we spoke to Foery about what to keep in mind. “The first thing you should know is what type of experience does the broker have writing these types of policies? You want to know how how they have been doing this,” he explains. “Plans can get complicated, with many variables, because there’s so much more at stake, someone writing their very first policy is a bit of a risk.”
The last thing you or your broker wants is a contract that’s written which is not enough to cover a disability if it should come to that.
In addition, Foery says to keep these points in mind when shopping around:
- Experience is important, but you also want someone you can trust.
- Similar to how you might shop around to different car lots for pricing (and not accept the first deal that comes your way, your agent should provide you with multiple quotes).
- The agent you work with should have access to multiple carriers and they should be highly-rated companies as well (look for A++) and leave it up to your broker.
- You want to fully understand the “definition of disability” listed in the policy. Ask for an explanation.
- Cheaper does not mean better.
Individual disability benefits could be worth a closer look
Individual income policies can supplement your income if an unexpected life event causes you to miss work and your ability to earn a paycheck. Because there are various factors to consider, it could be a good idea to speak with an agent specializing in individual insurance coverage or schedule time with your broker to find out if they can suggest a policy that makes the most sense for your needs.
Best of luck as you research different vendors on the marketplace, and if you have any questions, OnPay’s team of experts is here to help.
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.