Home > Personal Finance > Do You Need Disability Insurance?

Comments 1 Comment

Imagine you had a machine that sat in the corner of your office and generated the equivalent to your entire annual salary. It dependably spits out money, month after month, year after year, without fail. Would you purchase a warranty on that machine? Would you call your insurance agent and buy an insurance policy to protect your money machine? Of course you would.

Well, that machine is you. A disability policy provides the assurance that your “machine” can continue to generate a consistent income each and every year, if you become sick or injured and unable to work. Most of us have purchased a life insurance policy or have one that is provided to us at work. However, many do not own any disability insurance, or are woefully underinsured. I believe that disability insurance is equally important, if not more vital than life insurance. Whether you are married, single, with or without children, owning a disability insurance policy is critical to your financial security if you rely on your earned income to pay your bills. Once you can afford to retire, you no longer have the need for coverage and can let it go. (Full Disclosure: As a Certified Financial Planner, I do sell disability insurance.) 

How Much Do I Need?

You should own enough disability insurance to pay your non-discretionary expenses. If disabled, you might not be able to afford vacations or entertainment, but you will still need to pay your mortgage or rent and utilities. [Editor’s note: Failing to pay loans and everyday bills can seriously damage your credit scores and subject you to debt-collection activity. To keep an eye on how your credit is faring, you can get two free credit scores with regular updates from Credit.com.]

In my experience reviewing my clients’ policies, most disability insurance companies limit the payout to 60% to 75% of your pre-tax income. The reason for this limitation is that they do not want to incentivize you to become disabled. Obviously, most of us do not want to be disabled, but fraudulent claims are always a possibility with unscrupulous people. If you pay the disability insurance premium with after-tax income, then a 60%-to-75% benefit could replace most, if not all, of your after-tax take home pay.

What If I Already Have Benefits at Work?

If your employer provides disability insurance for you, consider yourself one of the fortunate few. According to 2014 data from the Bureau of Labor Statistics, only a third of American workers (in the private sector) have long-term disability through their employer.

If your income includes a bonus, chances are that bonus is not covered. As I review my clients’ employee benefits, I have seen that most of the disability benefits only cover the base salary and do not include the bonus. So if your total compensation of $70,000 comprises $60,000 in base salary and a $10,000 bonus, your annual benefit would likely be between $36,000 and $45,000. If your employer pays all of the cost of this benefit, then the disability payments to you would be fully taxable. You could, however, purchase additional coverage on your own to cover the bonus. Typically you might qualify for at least an additional $7,000 to cover your bonus, bringing your total disability benefit up to $43,000 to $52,000 per year.

Disability insurance isn’t cheap: There are many factors, including age, gender and occupation, that can significantly affect the premium; you can easily pay 1% to 3% of your annual income for it, but not having it when you need it could be devastating to your finances.

Image: shironosov

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

  • Robert

    Great article, Clark! Thanks for simplifying the concepts.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team