How to tailor disability insurance coverage for your needs

By Posted : 09/24/2013

woman in wheel chair on beachWhen you select disability insurance as an employee benefit during open enrollment, you probably just check a box to say "yes."

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But if you're buying an individual disability insurance policy, you'll need to do some homework.

Disability insurance -- whether it's through an employer or a policy you buy yourself -- pays out a percentage of your income if you get sick or injured and can't work. Short-term disability insurance typically covers you for three months, and long-term disability insurance kicks in after the short-term period ends. Long-term disability usually lasts for two, five or 10 years, or until age 65 or 67, depending on the policy.

Most financial advisers say disability insurance is a must. The greatest asset you possess, after all, is likely the ability to earn income through work, says Brett Virgin, a partner at SoundRiver Advisors in Atlanta.

Think it can't happen to you? About 30 percent of 20-year-olds today will become disabled and unable to work for at least three months sometime during their careers, according to the Social Security Administration.

Disability policies through work are one-size-fits-all, based on what an employer decided to buy for its workforce. With an individual policy, you can tailor the coverage to fit your needs.

A variety of features are available when you buy your own coverage. Here are some common ones to know.

Inflation protection

A cost-of-living adjustment rider, or policy add-on, will increase benefits to keep pace with inflation if you become disabled. Say, for instance, you become permanently disabled and unable to work at age 30. Imagine how inflation would erode the value of your benefits by the time you reached middle age.

Virgin recommends this rider for younger people. He says the option adds 15 to 25 percent to the cost of a policy.

The extra cost probably isn't worth it if you're nearing retirement, though.

Guaranteed insurability

This feature lets you purchase additional coverage periodically, regardless of your health. "Having that option is really helpful, and it's relatively inexpensive" says Amy Rose Herrick, a Chartered Financial Consultant and insurance agent with offices in the U.S. Virgin Islands and Tecumseh, Kan.

Says Virgin: "I wouldn't buy it as a 55-year-old, but at 22, it's important."

Waiver of premium

Virgin strongly recommends a waiver of premium rider. With this feature, you don't have to pay the disability insurance premium while you are disabled and collecting benefits.

Own-occupation

Generally an own-occupation policy means you can collect benefits if a disability prevents you from performing the duties of your own occupation -- even if you could perform some other type of work. Own-occupation policies are geared toward highly trained professionals, such as physicians, and the definitions for the policies vary.

The feature might make sense if you're a highly trained, high-wage earner, such as a neurosurgeon, and would take a big cut in pay if you had to work in some other field, such as teaching, Herrick says. "It's an individual decision."

Extra coverage for severe disability

In addition to paying a percentage of your salary, a policy with a catastrophic rider pays additional money if you're unable to perform two out of six "activities of daily living" or have a cognitive impairment. The six activities of daily living are eating, bathing, dressing, toileting, continence and transferring (such as moving from a wheelchair to bed).

Virgin says the rider adds about 10 percent to the cost of a disability policy.

Partial disability

A policy that covers partial disability would pay out a portion of benefits if you were able to work only part-time.

Otherwise, "some policies pay you nothing," Virgin says, if you can work a little.

He estimates coverage for partial disability increases a policy's cost by about 15 percent.

Guaranteed renewable and non-cancelable

This means the policy cannot be canceled, premiums can't be hiked and the provisions cannot be changed as long as you pay premiums on time.

Retirement savings protection

This feature replaces the contributions to retirement savings while you're disabled and unable to work. The Guardian's Retirement Protection Plus rider, for instance, pays 100 percent of what you normally set aside for retirement, as well as any employer matching contributions, into a trust. A trustee invests the benefits at your direction.

Return of premium

Less common than other features, this option refunds a portion of the premiums you paid after a certain number of years.

"Not every company offers it," Herrick says.

Metropolitan Life's "refund of premium" rider returns half the premiums every five years, minus any claims paid, as long as the policy lasts.

Return-of-premium options typically add about 40 percent to 60 percent to the annual premium. Some advisers say you're better off investing that extra money outside the disability policy. Otherwise you risk losing the money if you become disabled because the benefits are subtracted from the refund.

Other options besides these are available, too, and each company has different names for the various riders. Talk to a trusted financial adviser who has in-depth experience with disability insurance to help you sort out the choices.

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