Paying Bills Even If You Can’t Work
If you are like most of our other clients with high incomes, the single greatest asset your family has is your earning power. This reality motivates most people to buy life insurance as protection against a premature death. For most people, purchasing life insurance is “common sense.” While most people with whom we speak are underinsured, they do have at least some protection against a premature death. However, most Average American professionals, entrepreneurs, business owners, and executives often overlook a more dangerous threat to their long-term financial stability—their own disability. What is the risk that the average individual will suffer a disability? According to marketing materials of more than one life insurance company:
“Probability of at least one long-term disability (90 days or longer) occurring before age 65 is: 50% for someone age 25; 45% for someone age 35; 38% for someone age 45; and 26% for someone age 55.”
Inadequate disability income insurance coverage can be more costly than death, divorce, or a lawsuit. Responsible financial planning includes planning for the best possible future while protecting against the worst possible events. No one ever plans on becoming disabled—though half of those aged 25 will have a disability of three months or longer at least once. This chapter explains not only why you need disability insurance, but also what to look for in a disability policy.
The Need For Disability Insurance
In our opinion, the disability of the family breadwinner can be more financially devastating to a family than premature death. In both cases, the breadwinner will be unable to provide any income for the family; however, in the case of death, the deceased earner is no longer an expense to the family. Yet, if the breadwinner suddenly becomes disabled, he or she still needs to be fed, clothed, and cared for by medical professionals or family members. In many cases, the medical care alone can cost hundreds of dollars per day. Thus, with a disability, income is reduced or eliminated and expenses increase. This can be a devastating turn of events and can lead to creditor problems and even bankruptcy.
If you are older (near retirement) and have saved a large enough sum of money to immediately fund a comfortable retirement, then you probably don’t need disability income protection. Of course, you may have some long-term care concerns, but that is covered in the next chapter. On the other hand, if you are under 50 years old, or if you are older than 50 and have several pre-college age children, you should consider the right disability insurance a necessity. The challenge is determining what type of disability income policy is “right” for you.
Employer Provided Coverage Often Inadequate
If you are an employee of a university, HMO, or other large corporation, your employer may provide long-term disability coverage. The premiums are probably discounted from what you would pay for a private policy. We advise you take a good look at what the employer-offered policy covers, and buy a private policy if you and the insurance professional on your advisory team decide you need it. For many people, this makes a lot of sense because employer-provided group policies are often inadequate. They may limit either the term of the coverage or the amount of benefits paid. For instance, benefits may last only a few years or benefit payments may represent only a small part of your annual compensation. Since this is most commonly an employer-paid benefit, the money received during your disability will be income taxable to you. For most, this arrangement would result in your taking home less than half of the original amount in your paycheck after taxes are paid!
Give Yourself a Check-Up
Most people with employer-provided disability insurance coverage will find the benefits inadequate. To help you determine where your existing coverage may be lacking, we have provided some questions for you to ask when you are giving yourself an insurance check-up. When you are ultimately working with the insurance professional on your advisory team, you should keep some of these questions in mind as well. They will help you better compare coverage options from different companies so that you can find the best policy for your specific circumstances and goals. Below are a list of some questions you should ask yourself as well as short explanations of the appropriate answers:
· How long does the disability coverage last?
· How much is the benefit? (Some plans may cap the benefits at $5,000 per month)
· What percentage of your income is covered? (Generally, you cannot receive more than 60% of income and the benefit is capped at $7,500 or $10,000, depending on your age). Though most group LTD plans are good for the purpose that they serve, they are only a partial cure. Because of the limitations or ‘cap,’ they have a built—in discrimination against higher income employees—like you!
· Who pays the premiums? (TIP: If you pay the premiums yourself, and not as a deductible expense through your business or practice, your benefits will be tax-free.) You may be seduced by the income tax deduction of the premiums, but the extra tax burden today is much easier to swallow than the tax burden will be if you suffer a disability and have a significantly reduced income and increased expenses. When you and your family need the money the most, you will have more.
· Is the policy portable, or convertible, to an individual policy if you leave the group? If so, do you maintain your reduced group rate?
· If your business distributes all earnings from the corporation at year-end in the way of bonuses to all owners/partners (typical of C-corps as a way to avoid double taxation), you should see whether these amounts are covered by the group policy. If not, and if bonuses or commissions make up a substantial part of your income (which we have seen to be the case with many people), you’ll probably need supplemental coverage.
· What is the definition of disability in the group policy? Own-occupation, any occupation, or income-replacement? (Please see the discussion of these three terms below.)
· Are your overhead expenses covered if you are disabled? If you can’t perform your duties at work, will the business keep paying you? If you can’t generate income for the business, many of your expenses will keep on piling up, won’t they? For professionals, a business overhead expense policy also covers hiring an outside professional to replace the insured during disability for up to two years.
Getting The Best Insurance Coverage For The Money
Now that you have given yourself a check-up and realize that you may need a new or supple-mental insurance policy, you need to know what to look for in order to get the best coverage available at a reasonable rate. The following questions are important for you to ask when considering a disability policy.
What is the benefit amount? Most policies are capped at a benefit amount that equals 60% of income. Some states and insurance companies have monthly maximums as well. You have to ask yourself how much money your family would need if you were to become disabled. Generally, you want to find companies that offer at least 60% of pre-disability after-tax income with maximums of at least $7,500 or $10,000 monthly. There are additional monthly benefits of $5,000 to $25,000 per month available through more specialized channels for those high earners who want more monthly income than the traditional limits.
What is the waiting period? This is the period of time that you must be disabled be-fore the insurance company will pay you disability benefits. The longer the waiting period before benefits kick in, the less your premium will be. Essentially, the waiting period serves as a deductible relative to time—you cover your expenses for the waiting period, then the insurance company steps in from that point forward. This is not unlike the deductible you have on your car, except that auto insurance deductibles are in the form of amounts paid ($100, $250, $500, etc.), not relative to a period of time. If you have adequate sick leave, short-term disability, and an emergency fund, and can support a longer waiting period, choose a policy with a longer waiting period to save money. Though waiting periods can last as long as 730 days, a 90-day waiting period may give you the best coverage for your money.
How long will coverage last? It’s a good idea to get a benefit period of coverage that lasts until age 65, at which point Social Security payments will begin. Be aware that many policies cover you for only two to five years. Unless you are 62 to 65 years old, this would be an inadequate period because most people want coverage that pays them until age 65. Unless you are so young that you haven’t yet had time to qualify for Social Security, a policy that provides lifetime benefits, at costly premiums, is generally not worth the added expense.
What is the definition of disability in your policy? Definitions vary from insurance company to insurance company, and even from policy to policy within the same company. The definition of disability used for a particular policy is of the utmost importance. The main categories are Own-occupation, Any-occupation, and Loss of Income. The Own-occupation policies, which pay a benefit if you can’t continue your own occupation (even if you can and do work another occupation after the disability), are the most comprehensive and, of course, the most expensive. Two important elements to look for in an Own-occupation policy are:
1. Are you forced to go back to work in another occupation?
2. Will you receive a partial benefit if you go back to work slowly after the dis-ability and still make less than you did before the disability?
Does the policy offer partial benefits? If you are able to work only part-time instead of your previous full-time hours, will you receive benefits? Unless your policy states that you are entitled to partial benefits, you won’t receive anything unless you are totally unable to work. Also, are Extended Partial Benefits paid if you go back to work and suffer a reduction in income because you cannot keep up the same rigorous schedule you had before you became disabled? For example, this would be an important benefit for anesthesiologists, as they often work ridiculous hours in their younger years and most likely will work less after any disability.
Important Note: Partial benefits may be added on as a rider in some policies and should be seriously considered, as only 3% of all disabilities are total disabilities. Some policies even have a recovery benefit that, in the event that a business has lost clients during the disability due to the insured not being able to service them and the insured has suffered a loss of income because of this, there may be a benefit payable. The insured does not have to be disabled at all—there can be just loss of income due to disability-related attrition.
Is business overhead expense (BOE) covered? When you go out on your own, the last thing you think about is how you won’t be able to pay your bills. Whether you have $10,000 or $20,000 of monthly disability benefit, you likely don’t have enough to cover your lost income PLUS the costs of running the business. Though most companies have limited how much an individual can get in monthly benefit (often 60% of after-tax monthly income—capped at $10,000 per month), many carriers still offer up to $25,000 or more per month to cover business overhead expense. Many business owners who contact us have failed to implement this important defensive policy.
Is it non-cancelable or guaranteed renewable? The difference between these two terms—non-cancelable and guaranteed renewable—is very important. If a policy is “non-cancelable,” you will pay a fixed premium throughout the contract term. Your premium will not go up for the term of the contract. If it is “guaranteed renewable,” it means you cannot be cancelled, but your premiums could go up. As long as non-cancelable is in the description of the policy, you are in good shape.
How financially stable is the insurance company? Before buying a policy, check the financial soundness of your insurer. If your insurer goes bankrupt, you may have to shop for a policy later in life, when premiums are more expensive. Standard & Poor’s top rating for financial stability is AAA. A.M. Best Co. uses A++ as its top rating for financial strength. Duff and Phelps rates companies on their ability to pay claims and uses AAA as its highest rating. Moody’s uses Aa1 to rate excellent companies. There are no guarantees in life, but buying a policy from a highly rated company is the safest bet you can make and we would not recommend gambling on your disability insurance to save a few dollars.
Other issues to consider when determining if you are getting the best disability insurance coverage for your money so that you can avoid financial disasters caused by the disability of the breadwinner in your family include:
· Increased Coverage
· Cost-of-Living Increases
· Return-of-Premium Waiver
· Unisex Pricing
· HIV Rider
· Multi-Life Pricing Discounts
· Protection of Future Pension Contributions
Disability Of A Business Partner
The disability of a business partner has the potential to be just as financially crippling as the disability of the family breadwinner. There is a strong financial tie between business partners. The financial dependence between business partners can be even stronger than that between spouses. When a partner becomes disabled, the business will undoubtedly lose significant revenue, while possibly facing increased costs in an attempt to replace the disabled partner. This will put a significant strain on the remaining partner who now needs to run the business without the help of the deceased partner and replace the income of the disabled partner. Absent a buy-sell agreement tied to disability income insurance with a lump sum payout to generate funds to buy out the disabled partner and have sufficient funds to pay for a replacement physician, the end result could be financial devastation for the remaining partner and the business.
The likelihood of a disability is greater than the probabilities of a premature death, a lawsuit, and a bankruptcy combined. Doctors see patients every day who are hurt and can’t go back to work. Most Doctors know this is a risk, but fail to adequately address it in their own planning. A disability income insurance policy is the best way to protect your future income. We cannot overstate the importance of having a comprehensive disability policy as part of any personal financial plan and a policy as a funding mechanism for a buy-sell agreement in the case of the disability of a business partner. This is handled in Lesson #5, where you will learn how to turn your practice into a financial fortress. For now, let’s move on to the next chapter, where we will show you how to manage health risks that may arise after you retire.