If you’re a small business owner or independent contractor, you already have a lot to worry about. For starters, you’re completely in control of how much money you’re making — sick days and vacations don’t mean the same thing as when you worked for "the man." You’re also entirely in charge of your own financial safety net, including insurance products. But while you’re thinking about health insurance or life insurance, you may be missing a crucial type of insurance: long-term disability.
What is long-term disability insurance?
Long-term disability insurance is an insurance product designed to replace your income if you become disabled. The best policies cover your entire paycheck (after taxes) and will pay until your disability ends or until you retirement, whichever comes first. In most cases, it’s a pretty straightforward product, but it can get complicated if you’re a small business owner or independent contractor.
What do you mean, complicated?
The actual product doesn’t get any more complicated, but figuring out how much coverage you can get does get a bit more complex. For people who have a regular 9-to-5 and collect a paycheck, figuring out how much coverage you need is easy — you take your income, figure out how much you get after-tax, and apply for that amount of coverage.
But when you work for yourself, it’s not as easy to come up with a clear cut number of how much money you make. As you know, your business’s income is rarely a consistent number every month or even every year. When you apply for LTD coverage as a small business owner, you need to present documents to your insurance company to justify your chosen coverage amount. (Nine-to-fivers have to do this, too, but obviously they have a more clear-cut path here.)
How do I prove my income to the insurance company?
If you’ve been a small business owner or independent contractor for at least two years and you have two years of tax returns as a small business owner, you’re in luck! Those tax returns are literally all you need to show to the insurance company.
Of course, those tax returns may not represent your current income levels. If you want your coverage to be based on your income this year, your insurance company will probably ask you for a profit/loss estimate to prove that your income is going up. If you have signed contracts from clients, that’s also a huge help.
Note that insurance companies are going to cover your take home pay, not what your business made.
What if I’ve been doing this for less than two years?
Good news first: as long as you’ve made some kind of income before, you’ll be able to buy coverage. If you had a job in the same industry, you can get coverage that amounts to 75% of your after-tax income from that job. More good news: if you have signed contracts from clients that prove future income, you can base your coverage amount on that instead of tax returns. Your independent broker will look at numerous insurance carriers to make sure they find the best fit for your situation.
Bad news: if you don’t have any of that, you’re out of luck until you get two years of tax returns or sign some contracts.
Back to good news: there is actually a loophole depending on what career path you chose. Some insurance companies have this thing called a "starting practice limit," which is a minimum amount of LTD coverage you can get even if you can’t prove income. Basically, if you chose a career with a high income potential, the insurance company will insure you even if you can’t prove that income yet. This is true for lawyers, doctors, and software engineers, among other career paths. Make sure to buy your policy with a [glossary title="Future increase rider" text="This is an optional rider that protects your future earnings. When you buy a disability policy, it is for a defined benefit amount that does not grow over time. The rider locks in your insurability, which means you can increase the benefit amount in line with your rising income regardless of any changes in your health status." align="bottom"]future increase rider[/glossary] so you can increase your coverage as your income goes up.
Are my premiums tax deductible?
Nope. On the bright side, if you do ever need to collect the benefit, it will be tax-free.
What if I have employees I need to pay or other business overhead?
Then you need to look into business overhead expense (BOE) disability insurance. BOE will pay for your business’ overhead expenses in the event that you become disabled. That means it will pay for things like rent, utilities, salaries, payroll taxes, postage, accounting fees, and more. Basically, if you need it to run your business, BOE probably covers it. BOE insurance is typically short-term coverage, covering about one to two years of expenses.
BOE does not replace a personal LTD insurance policy. They are two separate products that cover two different needs.
However, you may be able to save money by buying these two products from the same insurance company. Talk to your independent agent if you have an interest in BOE.
Why is long-term disability insurance worth it?
Because you have about a 25% chance of experiencing a disability at some point in your life, and LTD is the best way to make sure you’re able to afford your rent, mortgage, groceries, medical bills, and life in general while you’re disabled. Disabilities aren’t just caused by workplace accidents, either — in fact, most disabilities are due to chronic conditions or diseases like cancer. LTD is the only insurance product that will cover your income for the entire duration of your disability, it’s a crucial part of building a financial safety net.
Image: Bench Accounting