The Importance of Disability Insurance in Your Financial Plan
I recently visited the home offices of Ohio National Financial Services in Cincinnati, Ohio, to discuss the importance of having a disability insurance policy with Jeff Wheatley, a disability income specialist there. Jeff has been in the disability insurance business since 1978, in both policy sales and product development, and we went on to discuss how having the maximum disability coverage is an essential part of your comprehensive wealth plan.
First, Jeff helps us understand what disability insurance coverage is – a policy that steps in to help you maintain your current standard of living in case of illness or injury that occurs over a long period of time. A disability policy is designed to protect the asset of your income, and will not only help pay your bills, but will prevent you from worrying about filing bankruptcy or dipping into assets that you’ve designated for long-term, such as a college fund or retirement account, and using them for a short-term need.
When people think of their assets, they tend to think of the tangible things such as their house or their car, but it is important to recognize that your income and your ability to earn it is your greatest asset over time, and therefore, it is essential to protect it with the proper insurance, as we would with any of our other assets. In fact, when we look at this in numbers, if you take someone who earns $120,000 per year, from the time they are 40 to when they retire at 70, the potential income asset is upwards of $3 million. Compared to a $700,000 house or a $40,000 car, this clearly is the greater asset.
Probability of Becoming Disabled is High
When asked to consider disability insurance, people tend to adopt the “it won’t happen to me” line of thinking. But when you look at the statistics they are staggering – according to the Council for Disability Awareness (www.disabilitycanhappen .org) one in every four people in the U.S. in their 20s and 30s will become disabled before the age of 65. Most of us don’t realize how many people today are disabled and are collecting Social Security Disability benefits. In fact, if you took these people and put them all in one state, that state would be the 9th largest state in America. The probability of becoming disabled is high, in fact, much higher than other dangers to our assets. According to Jeff, the chances of your house burning down to the ground are one in 10,000, and one in around 700 cars are totally destroyed in an accident, yet insuring these assets is a top priority for all of us. The loss of your income can create a far worse downward pressure on your wealth curve when you consider the devastating affect it can have on your wealth and the wellbeing of the people who depend on you.
Impact on Wealth is Devastating
Most of us fail to ask the question of what life would be like if we were unable to work for a few years due to injury or illness. When talking to people who have been disabled, the consensus seems to be that most people would run out of money after being disabled for only five years. Becoming disabled has also forced many people into an early retirement – a scenario that can wreak havoc on your long-term financial plan.
Disability insurance can not only give us the ability to pay the bills, but it also protects our savings by preventing us from going into it due to lack of income. A one-year disability can cost you 21 years in asset accumulation. If you’re saving 10% per year, it takes you 10 years to save one year’s salary. When you become disabled, you will then spend a year going completely through the savings, and it will take you 10 years to build it back up. Your disability has now cost you 21 years in asset accumulation – 10 years to save, one year to go through your savings, and 10 more years to build it back up.
Everyone agrees on the importance of protecting your home from this kind of potential devastation. Your home is a $400,000 asset, worth much less than your income potential to retirement. Not many of us would consider forgoing their homeowner’s policy to save the $1200 per year in premiums.
A disability can also create many unanticipated expenses along with your fixed monthly bills. With every injury or illness there are uncovered medical expenses, possible cost of modifications needed to your home, i.e. handicap ramp, and costs relating to child care or time off your spouse may need to take from their job to attend to you. The costs of a disability can be huge – and the cost of disability insurance compared to other types of policies is relatively cheap.
Cost Compared to other Insurance is Low
Although the toll a disability can take on your financial wellbeing is huge, the cost to protect yourself from it is not. The average policy based on a $120,000 annual income is only about $3 per day, which compared to other insurance such as homeowner’s and automobile, is very low. This relatively small premium compared to the magnitude of what we are trying to protect is fantastic – to put that into numbers, based again on that $120,000 per year salary, and you are 45, from now until you are 70, that is $3 million of income potential, which you are spending $3 per day to protect. Our cars, which are around a $40,000 asset, are costing us $6 a day to insure.
The cost of the premium does create a downward pressure on your wealth curve, but if you do not own disability coverage and you do become disabled, you risk losing all of your wealth. I can show that this downward pressure created by paying the premium is small and can be made up for by a simple lifestyle modification to accommodate the monthly cost for the policy. If you are looking at acquiring $2 million in assets by retirement and decide at that point to buy the coverage, you would see your assets at retirement fall to roughly $1.92 million. When considering the potential fallout of losing your income for a few years due to disability, the small reduction in assets is no doubt completely worth the risk.
Disability insurance policies are available through a wide network of providers and can be suited to your individual occupation and needs.
For example, if you are in the medical profession and depend on your ability to perform surgery to grow your long-term assets, there is a specific policy that can accommodate this kind of coverage. Coverage is typically available to age 70, and there are policies available to protect you from only a partial loss in income due to disability. There are also “residual riders” that can be added to your policy which can protect your insurability at a young age so that you can continue to collect benefits without submitting to medical evidence. You can also purchase a “cost of living” rider, which will allow you an increase in benefits just as you might experience an increase in income over the years aimed at protecting your future lifestyle.
Benefits will cap out at somewhere between $17,000 and $20,000 a month, depending on your carrier, which gives an individual the ability to protect around 65 percent of your income. There is usually a 90-day waiting period before collecting benefits. You can purchase a “catastrophic rider” in case of severe disability preventing you from performing basic daily functions such as eating or bathing, which would give up to $10,000 in additional benefits per month. Disability benefits are tax-free and can be spent at will – there is no justification for reimbursement.
Case in Point
We spoke to Jerry Wood, an Ohio National agent who was disabled when he fell 40 feet from a hunting stand four years ago. Jerry sustained multiple injuries and fractures from the fall and has had a total of 13 surgeries over the four years. The disability caused his business to suffer dearly, and Jerry urges us to consider the maximum coverage when purchasing disability insurance. The waiting period on Jerry’s policy was six months, which he says was too long. Jerry did have a “waiver of premium” rider on his policy, which he says was invaluable. This coverage paid the premium on Jerry’s life insurance and converted his term policy to a permanent policy, therefore allowing the savings on this policy to keep growing.
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