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Don't overlook disability insurance

December 14, 2009

Your most valuable asset may be unprotected. It's probably not your 401(k) or home, but rather your future earning power. If you lose or damage the ability to earn a living, it can completely derail your retirement and education plans, and cause you to drastically cut back your spending.

For some reason, it's easier to imagine our mortality than our inability to work in our current profession due to disease or an accident. It becomes more tangible when you consider that one in three people between the ages of 35 and 65 will suffer a disability for 90 days or more, and the average duration of the disability is four years.

From an economic perspective, permanent disability is more dire than a premature death. Ironically one of the challenges with disability is that you continue to live! If you're disabled, you are still with us -- requiring food, care and shelter -- but are not able to generate enough income to meet your expenses.

My clients do not relish the idea of paying more money for insurance. Let's face it -- most would rather sock it away for their children's education or go out to eat more often than purchase long-term disability insurance. With them, we use an exercise called "which job would you want?"

Imagine job No. 1 paying $100,000 a year when you are well and absolutely nothing if you're disabled. Then there's job No. 2 that pays $97,500 a year in good times, and then when unable to work $60,000 a year. Which job would you want?

This is the decision we face when purchasing an individual long-term disability policy, which typically cost about 3 to 5 percent of the benefit annually. The second job is the same as the first position, but with the purchase of an individual disability policy.

Fortunately, most working at larger employers have long-term disability insurance. They tend to have a benefit of about 60 percent of income up to a certain level. For example, a $10,000 a month salary could translate into a $6,000 benefit per month if disabled. Often employers will pay for these policies, but even if you must pay the premiums they are usually a good idea.

Group long-term disability policies, those that are offered through employers, are usually much less expensive than individual policies. Another plus with group policies is that you don't have to go through medical underwriting. For these reasons, it usually makes sense to take full advantage of a long-term disability policy at work.

There are downsides to group policies. They can have a maximum benefit far below your income, and are rarely portable from one employer to another. In addition, they may force you to work in another profession soon after disability.

Most of my clients are entrepreneurs or medical professionals, poster children for long-term disability insurance. Entrepreneurs often don't qualify for group disability plans and can see their businesses run into the ground when they are disabled.

Medical professionals often have taxing and physically demanding jobs with high pay. If a surgeon comes down with carpal tunnel syndrome, he may see his income drop tens of thousands a month.

There are many considerations when purchasing individual disability policies. Non-cancelable policies to age 65 are recommended as they guarantee that your rates and benefit will not change. There are scores of other options, such as cost-of-living increases, elimination periods, residual benefits, Social Security offsets, differing underwriting standards and occupational definitions that boggle the mind.

With all of this complexity, it's important to work with an ethical agent who specializes in long-term disability policies. A knowledgeable financial planner can help guide you through the process of considering and purchasing a policy as well. It may be the most important financial decision you make.

Dave Gardner is a certified financial planner with a practice in Boulder. He can be reached through his Web site at yellowstonefinancial.com

Dave Gardner