How Much Disability Coverage Do You Really Need?
Most of us insure our homes, cars, and health but we often overlook one of our most valuable assets namely our income. If an illness or injury prevented you from working, how long could you keep up with your bills? Disability income insurance steps in to replace part of your income. The big question is: How much disability coverage do you really need?
Let’s unpack what goes into finding the right amount of coverage for your life and financial situation.
Why Disability Income Insurance Matters
According to the Social Security Administration, one in four 20-year-olds will experience a disability before retirement age. That’s a startling statistic to kip in mind if you depend on your income. Moreover, it underscores why disability insurance is so important for young professionals who have family and lifestyle to protect. It safeguards your earning power by providing financial stability if you're unable to work due to a medical condition or a catastrophic injury.
There are two primary types of disability insurance:
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Short-term disability (STD): Covers you for a few weeks up to a year.
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Long-term disability (LTD): Provides income replacement for extended periods of time sometimes until retirement age.
Both play a role, but long-term coverage is what prevents financial disaster in the most serious cases.
Start With the Basics: What Does Disability Income Insurance Cover?
Disability Income insurance typically pays out a portion of your income, usually between 50% and 70% of your income. Policies vary, but they cover most illnesses and injuries that could prevent you from working. It covers everything from chronic back pain and mental health issues to cancer or a car accident injury.
However, coverage amounts and definitions can sometimes vary. Some policies cover you if you can't do your current job, while others only pay if you can't do any job. Therefore, one needs to be careful on picking the right policy.
How to Determine How Much You Need
Figuring out your ideal disability coverage amount isn’t as simple as replacing your full income. Most insurance providers won’t let you insure 100% of it anyways. Here’s how to determine what you actually need:
1. Calculate Your Monthly Expenses
Start by identifying your essential monthly expenses:
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Rent or mortgage
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Utilities
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Groceries
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Transportation
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Insurance premiums (health, auto, etc.)
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Loan payments (student loans, car loans)
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Childcare or school expenses
Don't forget to include out-of-pocket medical costs, which could increase if you’re injured or ill.
2. Account for Existing Coverage
Many employers offer group disability insurance. Find out:
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How much it pays (usually 50%-60% of base salary)
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How long the benefits last
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Whether it covers bonuses or commissions
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Whether benefits are taxable (if your employer pays the premium, benefits are usually taxable income to you)
If the coverage isn’t enough and often times it isn’t enough consider an individual policy to supplement it.
3. Consider Other Sources of Income
Do you have savings, investments, a working spouse, or rental income? These can offset the amount of insurance you need. But be realistic. Even solid savings can erode quickly during a long disability.
4. Factor In Taxes
If your disability benefits will be taxed, you’ll need a higher benefit amount to net what you actually need. That’s why privately purchased disability income policies are valuable where benefits are usually not taxed.
5. Plan for Inflation and Long-Term Needs
If you’re young, you might be out of work for decades in a worst-case scenario. Look for policies with cost-of-living adjustments (COLA) to ensure your benefits keep up with inflation.
Rule of Thumb: 60-70% of Gross Income
A good general target for disability insurance is 60% to 70% of your gross monthly income. That’s usually enough to cover basic expenses. For high earners, special policies called high limit disability insurance can help you get closer to a full income replacement benefit.
Other Key Policy Features to Look For
Beyond the monthly benefit amount, here are some important features to consider when choosing disability coverage:
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Own-Occupation Coverage: Pays benefits if you can’t work in your specific profession, even if you could do a different job.
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Elimination Period: This is the waiting period before benefits begin. Longer periods mean lower premiums, but you’ll need more savings to cover the gap.
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Benefit Period: How long benefits last. This could be 2 years, 5 years, until age 65, or even for a lifetime.
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Residual or Partial Disability Coverage: Pays benefits if you can still work part-time or at reduced capacity.
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Non-Cancelable Policies: Lock in your coverage and premium so that the insurer can’t cancel or change the terms of your insurance policy.
When Should You Get Disability Income Insurance?
The best time to buy disability Income insurance is when you’re young and healthy. Premiums are lower, and you’re more likely to qualify without exclusions. If you wait until you develop a health issue, you may be denied coverage or charged significantly more.
Bottom Line: Think of Disability Insurance as Your Perpetual Paycheck
You wouldn’t hesitate to insure a $500,000 home, so why wouldn’t you ensure your ability to earn $6 million over your career? Ultimately, that’s what really is at stake when we talk about disability income insurance.
Need help assessing your disability income insurance options? Contact us today