Life and Disability Insurance Guide: Coverage, Costs, and Smart Planning

Life and Disability Insurance - Planning for the Unexpected

No one likes to dwell on death or disability but if someone relies on your earnings, these kinds of insurance are essential. Let’s discuss how life and disability insurance operate and how to calculate what you require.

Life Insurance - Protecting Your Loved Ones

Life insurance is for only one purpose: to replace your income and give your dependents financial protection in case you die. It’s not for you - you won’t need it. It’s for them.

The life insurance policy’s death benefit can help to:

Replace income lost for decades or generations
Erase the mortgage and other debt
Fund funeral and final costs
Pay for children’s schooling
Keep your family’s living standard

Term Life Insurance is the cheapest and most basic type. You purchase insurance for a set term typically 10, 20 or 30 years. If you pass away during that term your beneficiaries receive the death benefit. If you survive the term the policy ends and there’s no payment.

Term life is straight-up insurance with no investment element. That’s why it is inexpensive. A 30-year-old in good health may pay $30-$50 monthly for $500,000 of coverage.

Permanent Life Insurance comprises whole life, universal life and variable life. These policies offer lifetime coverage and accumulate cash value that you can borrow from or take out.

The downside? Permanent life insurance is 5-15 times more expensive than term life. That same $500,000 policy may run you $300-$500 monthly. For most of us term life is the way to go and putting the difference between term and permanent premiums into a fund typically brings higher returns.

How Much Life Insurance Do You Need

A general rule of thumb is 10-12 times your income but your true needs are based on your individual situation.

Take into consideration:

Replace Your Income for however long your family will require it. If you have children they may require help for 20+ years. Take your income times the number of years to obtain a starting point.

Pay Off Debts such as your home, your autos, credit cards and student loans. Your family shouldn’t be left with your debt load.

Cover Future Bills such as college tuition for your children. Four years of a state university is about $100,000 per child today.

End-of-Life Costs like funeral burial or cremation can quickly cost $10,000-$15,000.

Your Spouse’s Salary counts too. If they’re making $75,000 and you’re making $50,000 you don’t need as much coverage if you’re the only provider.

Here’s a rough way to calculate:

Gross income × years required = Income replacement
Add outstanding loans (mortgage, etc.)
Add future expenses (college, etc.)
Add final costs
Subtract liquid assets (savings, current life insurance) = Total life insurance required

For instance if you make $60,000 per year, require income replacement for 20 years have a $200,000 home mortgage, desire to pay $100,000 for children’s college, have $15,000 in final costs and $30,000 in savings:

$60,000 × 20 = $1,200,000

$200,000 (home mortgage)
$100,000 (college)
$15,000 (final cost)
$30,000 (savings) = $1,485,000 in coverage needed

It’s a big number but keep in mind term life insurance is cheap considering you’re young and healthy.

When You Don’t Need Life Insurance

Life insurance is not for everyone. You most likely don’t need it if:

You’re single with no dependents
You’re financially independent with sufficient assets to provide for survivors
Your children are adult and financially independent
You’re retired and no longer generating income anyone relies on

Don’t let anyone push you around into purchasing life insurance that you don’t need. Insurance salespeople are paid on commission so they stand to gain by selling you policies whether or not they’re truly needed.

Disability Insurance - The Coverage Most People Ignore

Here’s a frightening fact: you’re much more likely to become disabled in your working years than you are to die. And still, most people carry life insurance but not disability insurance. That doesn’t add up.

Disability insurance substitutes part of your income when you’re unable to work because of illness or injury. This may be due to a car accident, serious illness chronic condition or even mental illness.

Short-Term Disability generally lasts 3-6 months and replaces 60-70% of your pay. Most employers provide this as a benefit. It begins after a brief waiting period typically 1-2 weeks.

Long-Term Disability begins after short-term expires (or after 90-180 days if you do not have short-term) and may go on for years or until retirement. It typically replaces 50-60% of your income.

Consider it this way: if you couldn’t work for six months or a year would you be able to get by on savings? Most folks wouldn’t. Disability insurance bridges that gap.

Disabling Disability Insurance Jargon

Benefit Period refers to how long the policy will provide benefits. Policies may pay for 2 years, 5 years, 10 years or until age 65. Longer benefit periods cost more but give greater protection.

Elimination Period (or waiting period) is how long you must be disabled before benefits begin. Common periods are 30, 60, 90 or 180 days. Longer elimination periods mean lower premiums.

Own Occupation coverage is the best. It pays benefits when you are unable to perform the tasks of your particular occupation even if you might be able to do another job. A surgeon who loses fine motor skills would receive benefits under own-occupation coverage despite the fact that they would be able to work in another role.

Any Occupation coverage will only pay if you’re unable to work at any job for which you’re reasonably suited by education and experience. It’s much more difficult to qualify for and gives less protection.

The majority of disability insurance offered by employers is “any occupation” which sounds good until you understand how restrictive it is. If possible have an individual “own occupation” policy.

How Much Does Disability Insurance Cost

The cost of disability insurance varies based on a number of factors:

Your Age - younger individuals have lower costs
Your Occupation - office jobs are less expensive than physically hazardous occupations
Your Health - existing medical conditions add expenses or lead to exclusions
Benefit Amount - more income replacement is more expensive
Benefit Period - longer periods of coverage are more expensive
Elimination Period - shorter waiting periods are more expensive
Optional Riders - extra features add to premiums

As an approximate estimate pay 1-3% of your income per year for a good long-term disability policy. So if you earn $60,000 per year you may pay $600-$1,800 per year or $50-$150 a month.

Most people acquire basic disability protection through their jobs but the policies are typically limited. They may only pay “any occupation,” have minimal benefit ceilings or terminate when you quit your employer. Adding an individual policy provides you with protection to get back on track.

Key Disability Insurance Riders

Riders are extra features that add value to your policy. These are the most useful ones:

Cost of Living Adjustment (COLA) rider raises your benefit over time to keep up with inflation. Without it your buying power decreases if you’re disabled for several years.

Future Increase Option (or Guaranteed Insurability) allows you to buy additional coverage in the future without requiring medical underwriting. It is worth considering when you are young and anticipate that your income will increase.

Residual or Partial Disability rider provides lowered benefits if you are able to work part-time or diminished capacity. Most disabilities won’t keep you from working entirely but will limit your ability to earn.

Non-Cancelable guarantee assures the insurance company won’t be able to cancel your policy or raise your premium if you keep paying on time. This secures your rate.

Own-Occupation rider is worth saying again because it’s so valuable. Ensure your policy has this if at all possible.

Social Security Disability Insurance (SSDI) is available but it’s very hard to become eligible. The SSA employs a strict definition of disability - you have to be unable to perform any substantial work for at least 12 months or have a condition likely to lead to death.

Also:

It takes months or years for the approval process
Approximately 70% of initial requests are rejected
Benefits tend to be modest (average monthly benefit is about $1,500)
Even with approval, there is a five-month waiting period

SSDI can be considered as last-resort safety net and not your main disability insurance.

Life Insurance Missteps to Steer Clear Of

Purchasing Affordable Permanent Life When Term is More Economical - Insurance professionals prefer to sell permanent life since commissions are significantly more but individuals are generally more wisely served with term life and investing the saving.

Not Purchasing Sufficient Coverage - Don’t downplay how much your family will require. It is safer to have too much than insufficient.

Allowing Employer Coverage to Expire - If you quit your job your employer-sponsored life insurance typically terminates. Take out an individual policy so you never have a lapse.

Fraud on Your Application - Insurance companies can refuse to pay claims if they find that you falsified information while being underwritten. Present your health and lifestyle honestly.

Omitting to Update Beneficiaries - Changes in life such as marriage, divorce, birth and death should prompt you to update beneficiaries. You do not want your ex-husband or wife receiving your death benefit.

Delaying Too Long - Life insurance is most affordable when you are young and healthy. With each passing year, you pay more and you may gain health issues which could make coverage costly or unaffordable to obtain.

Disability Insurance Blunders to Evade

Dependent Only on Employer Coverage - Group disability insurance through employment is preferable to nothing but usually has big holes. Obtain additional individual coverage.

Selecting Too Long an Elimination Period - Sure longer waiting periods cost less but can you honestly do without income for 180 days? Select an elimination period equal to your emergency fund.

Omitting the Own-Occupation Rider - Any-occupation policies are more difficult to collect on. The own-occupation rider is worth the added premium particularly for professionals.

Not Reading the Fine Print - Know precisely what conditions and circumstances are covered and what’s not. Mental health disorders are usually capped at 2 years for instance.

Canceling Your Policy - Do not lapse your disability coverage until you are financially self-sufficient and no longer reliant on income earned at work.

When to Review Your Coverage

Life situations shift and your insurance requirements shift along with them. Evaluate your life and disability insurance when:

You marry or divorce
You have children
You purchase a home
Your income is substantially increased
You launch a business
You extinguish major debts
Your kids become financially independent
You’re on the verge of retirement

A yearly check-up is a good idea even if nothing significant has happened. Ensure your coverage is still what you need and that you’re not paying too much.

The Bottom Line on Life and Disability Insurance

Disability and life insurance may not be thrilling but they are worthwhile if anyone relies on your income. The reassurance that your family will be well-off if you lose your life is worth more than money.

This is what everyone should do:

Take term life insurance for 10-12 times your income (factored in for your unique requirements)
Get long-term disability insurance that replaces 60-70% of your income with an own-occupation rider if possible
Shop around for the best rates - prices vary significantly between insurers
Review coverage annually and update as your life situation changes
Don’t overthink it - having adequate coverage is more important than finding the “perfect” policy

The most difficult thing about life and disability insurance is getting started. After you have it in place, you can optimize and fine-tune down the line. But do yourself and your family a favor - don’t delay. Get covered today because tomorrow is not promised.

Last Thoughts on Insurance in General

We’ve been through a lot on these five pages - health insurance auto insurance, home and property insurance and life and disability insurance. If your head is reeling I completely understand. Insurance is confusing.

But here’s the thing I want you to always keep in mind: insurance is really all about protection and peace of mind. It’s about ensuring that when life hits you with a curveball - and it will - you’re not financially ruined.

Sure, insurance costs money. Sometimes a lot of money. But the price tag of going uninsured or underinsured is potentially disastrous. One serious illness, accident, lawsuit or death might wipe out decades of economic gains.

Consider insurance premiums as purchasing certainty in a world of uncertainty. You’re paying to have assurance that regardless of what happens you and your family will be financially okay.

My recommendation? Begin with the fundamentals:

Obtain health insurance even if you’re young and healthy
Have appropriate auto insurance with uninsured motorist coverage
Secure your home and possessions with homeowners or renters insurance
Purchase term life insurance if you have anyone who relies on your income
Take disability insurance since you have a greater chance of being disabled than dead

Then after you’ve got those basics covered you can consider extra coverage such as umbrella policies, certain riders and increased coverage limits.

Compare, ask questions, read your policies and check your coverage periodically. Insurance is not set-it-and-forget-it. Your needs evolve as your life does.

And keep in mind you don’t necessarily need to know every detail of each policy to make good choices. Just concern yourself with the essentials - what is covered, what isn’t, how much coverage you have, what you are paying and what your out-of-pocket expense will be if you need to make a claim.

The insurance business complicates things more than they actually need to be at times. Don’t let that stop you. You’re intelligent enough to make sense of this and the work is well worth it.

Because at the end of the day insurance is one of the most powerful financial tools on the planet. It allows you to shift risk to big corporations that are capable of managing it so that you can enjoy life without having to worry constantly about financial catastrophe.

That’s kind of valuable when you consider it.

Now for goodness’ sake stop procrastinating and go check out your coverage. Ensure you’re properly insured. Your future self will appreciate it.