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How Disability Insurance Works

How Disability Insurance Works

| April 04, 2024

Disability insurance (DI) can be complex, especially with taxes and coverage limits. Understanding these aspects is vital for ensuring sufficient protection during challenging times. Here are a few things you need to note.

Work Coverage

If you work for a medium or large-sized company, chances are you may already have some DI coverage through your employer. Here are some things you should know about how this coverage works.

Replacement Percentage

Many employer plans limit the percentage of your income they will replace. A common percentage would be 50-60% of your base salary.

Monthly Cap

This percentage is also typically capped out at a certain amount of dollars per month. For example, someone might receive 60% of their salary up to $5,000 a month. This cap means high earners may not receive enough to maintain their standard of living if they cannot work.

Types of Income

Various plans offer different benefit structures, with some solely covering base salary and others encompassing bonuses, commissions, or additional income streams. Such diversity complicates plan comparison and the assessment of actual coverage.

Self-Employment Challenges

Self-employed individuals, like consultants and small-business owners, have a particular challenge because they don’t receive any large group benefits. As such, they have a very large risk exposure to a potential disability.

They often must verify income, provide multiple years of tax returns or financial statements for eligibility, and face limited plan options with stricter underwriting due to this perceived higher risk. Understanding tax implications, whether paid with pre-tax or post-tax dollars, adds complexity.

Taxation Constraints

Tax-Free Vs. Post-Tax Premiums

Paying for your disability policy with pre-tax or post-tax dollars is an important decision. Every self-employed individual has a choice, and every corporation will give their employees an option as well. If you pay for your DI policy with pre-tax dollars and go on claim, the benefit will be considered taxable income to you, meaning much the benefit may not reach your pocket.

On the other hand, if you pay for your policy with post-tax dollars, it essentially makes the insurance more expensive. But the benefit would be tax-free to you, which would make it a substantially larger benefit on a tax-equivalent basis.

Private DI Coverage

DI limitations and complexities cause many people to choose to supplement their DI with private coverage to ensure they get sufficient income in case of disability. Insurers offering private DI determine the required monthly premium amount based on your average income from the last couple of years.

You decide on the waiting period you’re comfortable with before the policy begins paying benefits. Consider the duration of coverage in a worst-case scenario. For short-term coverage, six months to one year may be sufficient. Long-term coverage can have a benefit period as little as two years or until retirement or the age of 70, whichever is later.

Additional Optional Riders in a Private DI Coverage

Right to Buy More Coverage in the Future

You get the right to increase your coverage amount in the future as a guaranteed purchase option without needing another medical exam, even if your health has changed. The incentive is especially helpful if your income goes up significantly over time.

Part-Time Employment Guidelines

Check your policy definition regarding payment in case of part-time employment, as some coverages may allow reduced benefit payment if you can work part-time but not at your full capacity. However, others may consider you not fully disabled if you earn any income, canceling your benefits. Discuss this aspect with your insurance provider to understand your coverage.

Own-Occupation Rider

This rider pays you the full benefit if you cannot perform your specific trained occupation, even if you could do other types of work. It’s beneficial if your career requires unique skills or qualifications, while generally coming with higher premiums.

Contact Us Today!

As always, any member of the SKG Team is at the ready to answer any questions you may have about your options with disability insurance. Contact us today to find out how we can help you maximize your coverage.