By Dan Routh, CFP®, Fee-only Financial Planner with Old Peak Finance and spouse of a veterinarian.
“It will never happen to me.” That’s the first thought everyone has when they try to picture themselves becoming disabled in their working career.
I don’t blame them, after seeing my wife go through veterinary school, aside from the sleep depravity, most graduates are healthy, able-bodied 20 and 30 somethings eager to start their careers. New grads are used to working on just a few hours of sleep, granola bars, and take-out food in their 4th year and even through internships and residency.
Is it really that likely they could become disabled and need to take time off work temporarily or even permanently?
The reality is that for 20-year-olds, 1-in-4 will become disabled before reaching retirement age¹. Not exactly a stat to ignore, especially if you have monthly financial obligations like rent or student loans.
What is Disability Insurance?
Disability insurance replaces a portion of your income when you become disabled and can no longer work due to an illness or injury. Typically, you can only replace up to 60% of your income, and depending on who pays the premiums, the benefit may be taxable. To understand how disability insurance works, we first need to break out the two main types, short vs long term.
- Short-Term Disability (STD) – Covers the first 60 to 90 days after becoming disabled. Most people have STD insurance coverage through their employers. A healthy emergency fund can also serve this role if you don’t have coverage through work.
- Long-Term Disability (LTD) – Starts after an elimination period (usually 90 days), sometimes offered by your employer but more often purchased privately. These policies can provide coverage for a few years or even up to age 65.
Features to Consider When Buying or Evaluating Your Own Long-Term Disability Policy
When buying or evaluating your own long-term disability policy, it is important to vet the insurance carrier and policy features to ensure you are getting a good deal and proper protection. Premiums typically range from 1.5%-3% of your gross income and policies vary in features depending on the insurer. Be sure to look for the following riders and protections when shopping your policy:
- Own Occupation – You worked long and hard to become a doctor. If you become disabled, an own-occupation policy will pay benefits even though you may be physically able to perform and earn an income in a different job/industry.
- Non-Cancellable/Guaranteed Renewable – Guarantees the insurance company can never cancel your coverage as long as premiums have been paid.
- Income Adjustment/Future Purchase Option– Allows you to increase the coverage level on your policy to match your salary increases without going through additional underwriting (premiums will also increase). This is very important for young doctors growing in their practice or for doctors finishing internships/residency.
Taxation of Long-Term Disability Insurance
As mentioned above, the taxation of your disability insurance comes down to who pays the premiums. If you pay the premiums, the benefits are tax-free. Policies paid for by your employer are taxable to you. Why does this matter? Since disability income benefits are already capped to roughly 60% of your income, paying taxes on that amount will only further decrease your benefit, making it harder to cover your living expenses. If you have an employer-paid plan through work, you should consider buying a supplemental policy to make up for the shortfall in benefits due to the taxes paid.
Are You Adequately Covered on Just Your Employer Policy?
Employer-provided long-term disability insurance seems like a great perk, but it can come with its own set of limitations. Group long-term disability insurance, just like group life and health insurance, is designed to cover everyone in the group, from the healthiest to the not-so-healthy. Because of this, group policies tend to have a very restrictive definition of disability called Any-Occupation, making it harder for benefits to be paid.
Purchasing Insurance – Search the Marketplace
The most important part of shopping for any insurance product is looking at multiple insurance companies and multiple products. You should evaluate not only cost but also make sure you can get the best policy features like Own Occupation and future purchase options, etc.
For DIYers, there are now many online search tools to let you do your own comparison shopping, without ever speaking to an insurance agent. For those of you who prefer to work with someone, make sure you work with an independent insurance agent who can shop the marketplace and present 2-3 different options from various companies.
Protect yourself, protect your family, and don’t sleep on disability insurance.
About the Author
Dan is a fee-only Financial Planner with Old Peak Finance in Chapel Hill, NC, and spouse of a practicing veterinarian. Dan specializes in working with middle and late-career veterinarians and physicians to help them simplify their financial lives. You can connect with him via email at firstname.lastname@example.org or Twitter @DanRouthCFP.