A Guide to Disability Insurance: Does Coverage Replace Income?

Jul 24, 2010
Carol Finch

What is Individual Disability Income Insurance? - Photo by somadjinn

Disability insurance coverage helps replace income for individuals that become disabled. This may suit those that don't have employer or government plans.

Although some workers may be given group disability insurance by their employers and some may qualify for government help (i.e. workers' compensation and Social Security Disability Insurance) many have no protection in place. Those without company policies and the self-employed, for example, may benefit from buying their own disability insurance. How do these policies work and do they completely replace income?

What is Disability Income Insurance?

This type of insurance is designed to give income replacement coverage in the event of a disability that prevents the individual from earning a salary. Loss of income, even for a short term problem, may lead to financial problems. A longer term disability can wipe out savings and make it difficult to meet bill commitments. This kind of policy may help by paying an alternative income. Both short term and long term (LTD) policies are available.

How Does Individual Disability Insurance Work?

The premiums charged for disability insurance basically buy a replacement income if an individual becomes disabled under the conditions of the plan. Payments generally start after a set waiting period of weeks or months (the elimination period) depending on the policy and do not start immediately. Coverage can be taken out for a number of years or can be arranged to last until retirement age if the individual prefers.

Does Disability Income Insurance Replace Income?

A policy will pay out a percentage of income but not the full amount of a salary. This is usually set at around 60% of earnings. This may help people to meet most or all of their essential financial commitments and everyday living costs. Payments made for plans taken out on an individual basis are made tax-free.

How are Individual Disability Insurance Premiums Calculated?

The costs of coverage may vary from individual to individual and are based on various factors. These include:

The benefit period (i.e. how long payments will be made).
The income that will be paid out each month.
The elimination period.
The age, gender and occupation of the individual.

Adding riders to disability insurance may also affect costs. For example, adding a COLA (cost of living adjustment) to a policy will ensure that payments increase year on year but it will incur higher charges. The elimination period can also be used to manipulate premiums. Those that can wait longer to start payments, may see their premiums lowered. Those that want/need a short wait time may pay more.

Keep in mind that it may be worth comparing disability income insurance plans to find good deals. It is, however, worth remembering that lowering costs may reduce benefits and this may make a policy less effective if a claim needs to be made.

Those in the process of deciding whether they need individual disability insurance or those with a group plan that may need supplemental benefits may find the following articles useful:

Source: AHIP (" Individual Disability Income Insurance "). Accessed online 24th July 2010.