Disability insurance replaces your income while you can't work. If you earn a passive income, disability insurance can protect you in several important ways.
Disability insurance benefits replace your income while you’re disabled and can’t earn an income. If you receive wages or a salary from work, then you need disability insurance in case you become injured or disabled and can’t work. But if you earn a passive income, whether you need disability insurance depends on your personal situation.
Passive income (or unearned income) is income earned from investments, such as interest or dividends, and other sources like pensions, royalties, annuities, and alimony.
If you earn enough passive income to self-insure, you may not need disability insurance as much as someone who needs to work for their income. Some high earners may not even be eligible for disability insurance.
However, if there’s any chance that your passive income could run out, or become reduced due to changes in the market, then disability insurance could provide you the cash you need to live on while you recover from a serious illness or injury.
While many people may be able to live off their unearned income, returns are not always guaranteed. If your passive income runs out, or if your investments take a dip, you may not have enough passive income to live off of.
Having disability insurance before you decide to live off your passive income can prepare you for the possibility that you’ll have to return to work.
If you’re disabled, your disability insurance pays you monthly benefits until you recover or your benefit period ends. Disability insurance benefits replace around 60% of your gross income, which should roughly align when your income after taxes.
There’s also the chance that becoming disabled could significantly increase your day-to-day expenses, like the cost of medical care to treat your illness or injury. In that case, you may find that your passive income isn’t enough to cover the costs, and that disability insurance benefits could help make up the difference.
Whether receiving passive income can affect your ability to get disability insurance depends entirely on the insurer.
During the application process, you’ll go through underwriting, which is when the carrier takes all the information you submitted and decides what your final premium and benefit amount will be. Part of underwriting looks at your medical history, and the other part is financial underwriting. Every insurer has their own guidelines for underwriting.
If you earn a passive income, several outcomes are possible:
When you apply for disability insurance, some insurers will only offer you a reduced benefit if you already earn a passive income. While the amount differs between disability insurers, the reduction will generally be the lesser of one of the following:
The percentage by which unearned income exceeds your earned income, such as 10% or 25%
An annual dollar amount of passive earnings, such as $30,000 or $50,000
Other disability insurance companies may have a similar stipulation where the reduction is equal to one-half of any passive income earned over a certain dollar amount, like $1,500.
Many disability insurers don’t take any passive or unearned income into account when determining your benefits. If you have passive income and need disability insurance, a licensed representative at Policygenius can help you find a policy that won’t reduce your benefits.
Again, this is dependent on the insurer’s underwriting guidelines and the type of policy you’re taking out. Group disability insurance often doesn’t count passive income, but such a policy may not have enough coverage to help you maintain your normal standard of living should you become disabled. For the most coverage, you may need a long-term disability insurance policy with a benefit amount large enough to keep paying your mortgage or student loan bills.
If your net worth, whether from earned or unearned income, exceeds a certain amount, you may not be eligible for disability insurance coverage. Some insurers set this threshold for net worth as high as $10 million, but others set it at $2.5 million. High earners may be eligible for disability insurance, but their benefits could be reduced.
If you can’t get disability insurance coverage from one insurer, or another reduces your benefits too much, there are some insurers that offer full coverage. These insurers may charge higher premiums, but the price could be worth it when you become disabled and need to rely on those benefits to survive.
Get disability insurance when you’re younger and healthier, and it could save you thousands of dollars on premiums versus purchasing when you’re older. But if you’re an ambitious young person who expects to make a living off passive income when you’re older, buying disability insurance early means your benefits won’t be affected when you become professionally successful.
You just need to make sure your policy is guaranteed renewable and non-cancelable. These provisions mean that as long as pay your premiums on time, the insurer can’t cancel your policy, modify its terms, or raise your premiums. (Most policies already have these terms, but it’s always good to double-check before you sign up.)
You can even make sure that the policy accounts for the high income you expect to make, whether passive or earned, by adding the future increase option rider. With this extra coverage, your coverage can increase without the need for additional medical underwriting as long as you’re willing to pay higher premiums.
Social Security disability insurance (SSDI) is like commercial disability insurance except much harder to qualify for. It also only pays a small benefit amount, although it doesn’t cost anything to receive coverage.
The Social Security Administration, which oversees SSDI, does take earned income into account when determining your eligibility and how much you can receive in benefits. However, it does not count unearned or passive income for this purpose, no matter how much you receive.
Zack Sigel is a SEO managing editor at Policygenius. He covers personal finance, comprising mortgages, investing, deposit accounts, and more. His previous work included writing about film and music.