How Does Disability Insurance Work?

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How would you pay your bills if you became disabled and couldn't work? Whether a disability lasts months, years or the rest of your life, it can have a major impact on your ability to make an income and provide for yourself and your dependents. One way to safeguard your finances is by purchasing disability insurance, which provides a source of income when you can't work due to a short- or long-term disability. But how does disability insurance work, what does it cost and does it make sense for you?

How Does Disability Insurance Work?

Disability insurance protects against the risk that you'll be unable to earn a living due to a disability. If you become disabled, you'll file a claim with the disability insurance carrier, which reviews the claim to see if you're eligible for benefits. If approved, your insurer will provide a monthly payout that replaces a percentage of your income, usually between 50% and 70%.

Here are some key terms to understand when shopping for a disability insurance policy:

  • Premium: The amount you pay the insurer for the policy.
  • Payout: The benefits you receive from your policy after filing a claim.
  • Waiting period: Also called the elimination period, this is how long you must wait for benefits to kick in after you're declared disabled. Typical waiting periods are 30, 60 or 90 days, and you usually receive payment 30 days after the end of the waiting period. If you have a 90-day waiting period, for example, this means you'll generally have to go 120 days before you receive a check. Policies with shorter waiting periods cost more, so you can save money by choosing the longest waiting period you can financially manage.
  • Eligible disability: Unlike workers' compensation benefits, disability benefits pay out even if the cause of your illness or injury is unrelated to your job. However, eligibility for benefits can vary depending on your policy's definition of disability. For example, some policies pay benefits if you can no longer work at your current occupation or a similar occupation; others don't pay out until you are unable to perform any type of work. Some policies only cover disabilities from accidents, not from illness.
  • Benefit period: This is how long benefits continue to pay out. Short-term policies' benefit periods last a few months to a few years. A long-term disability policy's benefit period may last your whole lifetime. If a policy with lifetime benefits is out of your budget, experts recommend buying a policy whose benefit period lasts at least until retirement age, when you begin tapping into Social Security, Medicare and your retirement savings.

The following riders or add-ons generally add to the price of a disability policy, but may be worth the cost:

  • Cost of living increase: Some plans adjust benefits based on inflation or increases in the cost of living.
  • Partial or residual benefits: If you are partially disabled, the plan provides partial benefits. For example, if you can only work part-time, or can perform some of your normal job duties but not others, these plans would pay less than your full benefit amount.
  • Waiver of premium: After you have been officially disabled for 90 days, you can stop paying disability insurance premiums.
  • Return of premium: If you haven't made a claim within a certain time period specified by the policy, the insurer will refund a portion of your premiums.
  • Coordination of benefits: This type of plan sets a target amount for you to receive. After any other disability benefits pay out, the insurer makes up the difference between those benefits and the target amount.
  • Additional purchase option: The insurance carrier will let you buy more insurance later. For example, you may want more coverage as your salary or financial obligations increase.
  • Noncancelable policies: These are guaranteed to be renewed every year (as long as you pay your premiums on time) without a premium increase or a decrease in benefits.
  • Guaranteed renewable policies: Your policy will renew every year without a decrease in benefits; but your premiums may increase.

Noncancelable and renewable policies may both be canceled in some cases, such as if the insurer stops selling insurance to a certain type of individuals or in a certain location.

Short-term vs. Long-term Disability Insurance

The two basic kinds of disability insurance are short-term and long-term. Short-term policies generally pay benefits for three months to two years. Long-term policies usually start six months after the disability and can last from a few years up to a lifetime. Many long-term policies don't pay out until after your short-term policy has been exhausted.

How to Get Disability Insurance

Some employers offer disability insurance as part of their employee benefits package, and they may even pay the premiums. Your employer may offer you the option to buy additional disability insurance to supplement the coverage. If not, you can supplement it by purchasing an individual disability insurance policy on your own. If you do have an employer-sponsored disability insurance policy, check to see whether you can keep the coverage if you leave your job, and how much that would cost.

If your employer doesn't provide disability insurance, you can buy your own coverage. Your state's department of insurance can refer you to insurance agents who sell disability insurance. Working with an agent can help you figure out how much coverage you need, based on your assets, other types of insurance (such as mortgage protection insurance) and potential sources of income.

Protect Your Finances With Disability Insurance

You may have other potential sources of income after becoming disabled. For instance, if your disability is due to a car accident, your auto insurance may replace some lost income. Disabled military veterans may receive financial and other benefits through the Department of Veterans Affairs. You could also qualify for government financial assistance such as Social Security disability payments, housing vouchers, Medicare or Medicaid, or Supplemental Nutrition Assistance Program (SNAP), and might even be able to have your student loans forgiven.

If you do become disabled, a good credit score can be another important safety net, giving you greater access to credit, loans and financial services. Signing up for free credit monitoring from Experian can help you keep an eye on your credit health.