Purpose of Disability Insurance
Disability income insurance provides financial protection when illness or injury prevents someone from working. It's often called "paycheck protection" because it replaces lost income during a disability.
The Importance of Disability Coverage
The Income Protection Gap
| Risk | Protection Available |
|---|
| Death | Life insurance |
| Medical expenses | Health insurance |
| Property loss | Property insurance |
| Lost income due to disability | Often uninsured |
Disability Statistics
| Statistic | Reality |
|---|
| Likelihood of disability | 1 in 4 workers will become disabled before retirement |
| Average disability duration | 2.5 years |
| Leading causes | Musculoskeletal, cancer, mental health, cardiovascular |
| Financial impact | 48% of foreclosures linked to disability |
Key Point: Disability is more likely than death during working years, yet fewer people have disability coverage than life insurance.
Income Replacement Philosophy
Purpose of Disability Income Insurance
| Goal | Description |
|---|
| Replace lost income | Provide ongoing payments when unable to work |
| Maintain standard of living | Cover regular expenses |
| Prevent financial hardship | Avoid debt, bankruptcy, foreclosure |
| Bridge to recovery | Support until return to work or retirement |
What Disability Insurance Does NOT Cover
| Not Covered | Reason |
|---|
| Medical expenses | Covered by health insurance |
| Full salary | Benefits capped to prevent over-insurance |
| Investment losses | Not income protection |
| Business losses | Requires business overhead expense insurance |
Sources of Disability Income
Private Sources
| Source | Description |
|---|
| Individual disability insurance | Personal policies purchased from insurers |
| Group disability (employer) | Short-term and/or long-term disability |
| Business overhead expense | Covers business expenses during disability |
| Key person disability | Protects business from loss of key employee |
Government Sources
| Program | Eligibility |
|---|
| Social Security Disability (SSDI) | Work credits, strict definition of disability |
| Workers' Compensation | Work-related injuries/illnesses only |
| State disability programs | 5 states + Puerto Rico |
| Veterans benefits | Service-connected disabilities |
Social Security Disability Insurance (SSDI)
| Feature | Details |
|---|
| Definition of disability | Unable to engage in any substantial gainful activity |
| Duration requirement | Expected to last 12+ months or result in death |
| Waiting period | 5-month elimination period |
| Benefit amount | Based on lifetime earnings |
| Approval rate | Only ~35-40% of applicants approved initially |
Exam Tip: Social Security uses a strict "any occupation" definition—you must be unable to do ANY work, not just your own occupation.
Short-Term vs. Long-Term Disability
Short-Term Disability (STD)
| Feature | Typical Details |
|---|
| Elimination period | 0-14 days |
| Benefit period | 13-26 weeks |
| Benefit amount | 60-70% of salary |
| Common source | Employer group plans |
| Replaces | Sick leave coverage |
Long-Term Disability (LTD)
| Feature | Typical Details |
|---|
| Elimination period | 90-180 days |
| Benefit period | 2 years to age 65 (or longer) |
| Benefit amount | 50-70% of salary |
| Common source | Employer group or individual |
| Coordinates with | STD, Social Security, Workers' Comp |
How STD and LTD Work Together
Timeline:
Day 1-90: Short-term disability benefits
Day 91+: Long-term disability benefits begin
Individual vs. Group Disability
| Factor | Individual | Group |
|---|
| Underwriting | Individual health review | Guaranteed or simplified |
| Portability | Stays with insured | Usually ends with employment |
| Cost | Higher premiums | Lower (group rates) |
| Customization | Highly customizable | Standard plan design |
| Ownership | Insured owns policy | Employer owns policy |
| Taxation | Benefits tax-free if premiums paid with after-tax dollars | See taxation rules |
Taxation of Disability Benefits
| Who Pays Premium | Tax Treatment of Benefits |
|---|
| Employee (after-tax) | Benefits received tax-free |
| Employer | Benefits are taxable income |
| Shared | Proportionally taxable |
Example
- Employer pays 60% of premium → 60% of benefits taxable
- Employee pays 40% of premium (after-tax) → 40% of benefits tax-free
Key Point: Many financial advisors recommend employees pay disability premiums with after-tax dollars to receive tax-free benefits when disabled.