Disability Insurance Explained: Protecting Your Biggest Asset, Your Income

Your ability to earn an income may be your most valuable financial asset. Over a career, your earnings can add up to an enormous sum, funding your lifestyle, savings, retirement and your family’s security. If an illness or injury kept you from working for months or years, the financial consequences could be devastating. Disability insurance protects your income if that happens.

Why disability insurance matters

Many people insure their homes, cars and lives but overlook their income. Yet the risk of a disabling illness or injury during your working years is significant. Disabilities can result from accidents, but many are caused by illnesses, such as cancer, heart disease, back problems and mental health conditions.

Without disability insurance, a long-term disability could force you to drain savings, take on debt, sell assets or depend on family members. Disability insurance provides a portion of your income, helping you cover living expenses while you recover or adjust.

How disability insurance works

Disability insurance pays a portion of your income, often around 60% of your salary, though policies vary, if you can’t work because of a covered illness or injury. Benefits are typically paid monthly.

Benefits start after a waiting period, called an elimination period. The elimination period is the time between when your disability begins and when benefits start. Longer elimination periods generally mean lower premiums, but you’ll need savings to cover expenses during the waiting period.

Short-term versus long-term disability insurance

Short-term disability insurance generally covers a few weeks to several months. It typically has a short elimination period, often a week or two, and is designed to replace income during temporary disabilities, such as recovery from surgery, injuries or childbirth.

Long-term disability insurance can pay benefits for years, sometimes until retirement age, depending on the policy. It typically has a longer elimination period, often around 90 days, and is designed to protect against extended disabilities. Long-term coverage is generally considered more important, since long-term disabilities pose the greatest financial risk.

Some people have both types of coverage, with short-term disability bridging the gap until long-term benefits begin.

Where to get disability insurance

Many employers offer group disability coverage, sometimes at no cost to employees. Group coverage is often convenient and affordable, but it may have limitations, such as lower benefit maximums, stricter definitions of disability and coverage that ends if you leave your job.

You can also buy an individual disability insurance policy from an insurance company. Individual policies can stay with you if you change jobs, may offer more comprehensive coverage and can be customized. Premiums depend on your age, health, occupation, income and the policy features you choose.

A few states, including California, New York, New Jersey, Rhode Island and Hawaii, have state disability insurance programs funded through payroll, which provide short-term disability benefits to eligible workers.

Professional associations sometimes offer group disability coverage to members.

Key terms to check

The definition of disability is one of the most important features of a disability insurance policy. Own-occupation policies pay benefits if you can’t perform the duties of your specific job, even if you could work in another field. Any-occupation policies pay only if you can’t do any job you’re reasonably suited for based on your education, training and experience. Own-occupation coverage is more comprehensive and typically more expensive. Some policies use an own-occupation definition for an initial period, then switch to any-occupation.

The benefit amount and maximum determine how much you’ll receive, usually a percentage of your income up to a monthly maximum.

The elimination period determines how long you’ll wait before benefits begin.

The benefit period determines how long payments last, such as two years, five years or until retirement age.

Whether benefits are taxable depends on who paid the premiums. If your employer paid the premiums with pre-tax dollars, benefits are generally taxable. If you paid premiums with after-tax dollars, benefits are generally tax-free. This affects how much income you’ll actually receive.

Other features to consider include cost-of-living adjustments, which increase benefits over time to keep pace with inflation, residual or partial disability benefits, which pay partial benefits if you can work but with reduced income, and non-cancelable or guaranteed renewable provisions, which protect your coverage and premiums.

Social Security Disability Insurance

Social Security also provides disability benefits through Social Security Disability Insurance, or SSDI, for workers who have earned enough work credits. However, qualifying can be strict. SSDI requires that your condition prevent you from doing substantial work and be expected to last at least a year or result in death. The application process can be lengthy, and many initial applications are denied. Benefits may not replace much of your income, especially for higher earners.

SSDI is best viewed as a backup, not your only plan for income protection.

Review your coverage

Check what your employer provides and whether it would cover your essential expenses if you became disabled. Consider whether additional individual coverage makes sense, especially if you’re the primary earner for your household, have significant financial obligations or work in a profession where an own-occupation definition would be valuable. An insurance agent or financial planner can help you evaluate your needs and options.