You know the basics: long-term disability insurance (LTDI) can act as a form of income replacement if you experience a disability that stops you from working. (If you don’t know the basics, check out our comprehensive explanation of how long-term disability works and meet up with us in a few minutes.) But what does that term income replacement really mean? Will long-term disability really replace your full paycheck every month?
It helps to understand how your LTDI policy pays before diving into how much. Each month that you’re disabled and can’t work according to your policy’s definition of disability, you’ll receive a benefit, a payment in the equivalent of the benefit amount stated by your policy. The payment reoccurs as long as you remain disabled or until the benefit period ends.
When you’re shopping for a policy, you can specify what you want your benefit amount to be. While you can’t go crazy and request a million dollars per month, you can and should request almost your full take-home paycheck prior to becoming disabled. The average long-term disability insurance benefit should be between 60% and 80% of your after-tax salary.
Read on to learn more about how much long-term disability insurance pays:
Before you start shopping for a long-term disability policy, it’s worth taking a look at your budget to figure out exactly how much you would need every month if you lost your job due to a disability. Remember, you not only need enough to keep the lights on but also to cover any medical bills resulting from your disability that your health insurance doesn’t cover. The 60% to 80% figure will roughly equal your take-home pay because, unlike your salary, the benefit amount is not taxed as income.
An agent at Policygenius can make it easy to determine how much disability insurance you need. But, first, compare long-term disability insurance policies online to find a quote that fits your budget.
Here are a few things to keep in mind when calculating your ideal benefit amount:
Depending on the type of policy you have, you may be able to purchase less coverage, meaning your long-term disability insurance will pay you less when you become disabled. That’s possible if you have an own-occupation long-term disability insurance policy, which means that you only need to be so disabled that you can’t work at your current or most recent job. Own-occupation policies are more expensive because they that have a higher likelihood of paying out; however, you’ll be able to work another job that you’re qualified for and still get paid disability benefits.
The opposite of an own-occupation policy is an any-occupation policy. This type of policy pays disability benefits only if you can’t work at any job. This is a much stricter definition of disability to meet, so any-occupation policies have lower premiums, but may not offer the amount of coverage you need.
Mortgages, electricity, internet, food, health and life insurance premiums, etc. There are certain fixed expenses that you pretty much know you need to cover every month. It’s hard to say exactly how much of your income you use on fixed expenses — it’s different for everyone, obviously — but if you haven’t already, you should figure out this number, give or take a few hundred bucks. Use this as your baseline benefit amount that any LTDI policy needs to meet.
Books, movies, music, and other types of entertainment are typically not covered by your fixed expenses, but you’re not going to just stop consuming them because you’re using disability benefits. Same goes for other small luxuries, like eating out.
Your health insurance will probably cover most of your care. However, many people have to pay a high deductible before receiving care or have a health insurance policy that doesn’t cover every medical expense. Since you may not be earning an income while disabled, your LTDI coverage should be high enough to get you the care you need and help you recover.
If you already have a group long-term disability policy through your job, you may be looking to supplement it with a private long-term disability policy. In this case, you should look at the benefit you’re already receiving and see what percentage of your after-tax income it covers.
Assuming it doesn’t cover at least 60% of your income, you should figure out what your private benefit amount would need to be in order to get you, in total, 60% of your income from your two LTDI policies.
To put that into a formula: Group benefit amount [Example: 35% of post-tax income] + Private benefit amount [Example: 25% of post-tax income] = Total benefit amount [Example: 60% of post-tax income]
There is one huge wrinkle in this calculation, however: group LTDI benefits are taxable if the premiums are paid by your employer. Make sure you factor this into your math.
In some cases, it may be prohibitively expensive — i.e., you can’t afford the monthly or annual premiums — to get your ideal benefit amount. This typically happens if you work in a risky occupation or have had prior health issues.
There are some things you can do to help make your long-term disability insurance policy more affordable. For starters, you can try reducing your benefit period. The benefit period is the amount of time you’ll receive benefits. The longest benefit period you can get is up to your retirement age (age 67 or 70, depending on the insurer). But you can save money by reducing this your benefit period to just 10, five, or two years.
You can also try increasing your elimination period. The elimination period is the period of time between when your disability starts and when your insurance company starts paying out benefits. More expensive policies have elimination periods of either 30 or 60 days. You can save a little bit of money by switching to a 90-day elimination period without affecting how much your LTDI policy pays.
However, if you don’t have enough emergency savings to cover the six months between when you stop receiving a paycheck and when your insurance policy kicks in, a long elimination period can be disastrous. If you choose this option, make sure you’re covered either by emergency savings or a short-term disability policy.. If neither of these options lowers your premium enough, you’ll need to reduce your monthly benefit amount.
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.