What is disability insurance?

A way to replace between 60% and 80% of your monthly income should you become unable to work due to illness or injury

Derek Silva

Derek Silva

Published December 17, 2018

KEY TAKEAWAYS

  • Disability insurance replaces 60% to 80% of your income for a set period of time if you’re unable to work

  • An illness, injury, or other condition, potentially including COVID-19, that prevents you from being able to do your regular job could qualify as a disability

  • Disability insurance from employers doesn’t offer much coverage because they’re short-term plans and don’t apply if you leave your employer

  • The benefit payment from an individual policy is tax-free, but benefits from an employer plan may be taxed

Disability insurance (DI) is a form of income protection that pays you a portion of your monthly income if you can’t work because of an illness or injury. The level of income replacement that a plan offers and how long you get payments varies by type of DI.

There are three types of disability insurance. Short-term disability insurance (STDI) pays up to 80% of your gross monthly income, but lasts just three to six months. Many people have a short-term plan through their employer, but you will lose your STDI benefits if you leave your employer. Long-term disability insurance (LTD) pays up to 60% of your gross monthly income, and payments may last for anywhere from two years up until you retire.

Social Security Disability Insurance (SSDI), a free form of DI from the federal government, only covers individuals with a severe disability and is notoriously difficult to qualify for. Most people are better off with a short-term or long-term policy if they can afford it.

A private disability insurance policy is an often overlooked tool for building a financial safety net, but it can fill the coverage gaps left by health health insurance plans and life insurance policies. Even if you have short-term coverage from an employer, consider combining it with a long-term policy for more complete coverage.

In this article:

How does disability insurance work?

When you’re unable to perform your normal job duties because of an illness, illness, or other condition — whether or not it’s permanent — disability insurance replaces a certain percentage of your gross monthly income. It won’t completely replace your pay, but it provides enough so you can afford food and other necessities without drastically changing your lifestyle.

Like other insurance policies, you pay a monthly premium to keep your DI policy in effect. If something happens and you cannot work, you file a claim with the insurance company so you can receive a monthly payment, called a benefit. The benefit amount varies by type of plan, but it is generally 60% or more of your gross monthly pay. Benefits will pay out for a certain length of time, called a benefit period. Your benefit period depends on the type of plan you have.

Before you can apply for benefits, you have to go through the policy’s elimination period, also called the waiting period. The elimination period for a short-term disability is typically one or two weeks, and the most common elimination period for a long-term disability is 90 days. Policies with shorter waiting periods are typically more expensive (higher monthly premiums) and less-expensive policies have longer waiting periods.

Are disability insurance benefits taxable income?

Benefit payments from private disability insurance plans are usually tax-free. You may have to pay tax on benefits from an employer-sponsored policy. See if your disability benefits are taxable.

Disability insurance vs workers’ compensation

Workers’ compensation is covered entirely by your employer. Unlike disability insurance, which can cost a couple of hundred dollars per month in premiums, you don’t need to pay anything for workers’ comp. However, there are two important reasons to consider disability insurance in addition to workers’ comp.

Disability policies cover you regardless of where or how you sustain an injury (as long as you meet the policies definition of disability) but workers’ compensation only covers work-related injuries and illnesses.

Most disabilities happen off the job and therefore wouldn’t be covered by workers’ comp. For example, disability insurance would likely cover injuries from a car crash if they keep you out of work, but workers’ comp would not cover you unless the accident happened as part of your job.

Related article: State-by-state guide to workers’ compensation

Note, however, that if you sustain an injury at work and receive workers’ compensation, your private disability insurance benefits could be reduced by the amount you receive from workers’ comp.

Disability insurance riders

Disability insurance riders are optional add-ons that allow you to customize a policy to meet your specific income needs. Adding a rider may increase your monthly DI premiums, but it allows you to increase your benefit payment in certain circumstances. The following are common types of DI riders:

  • Cost of living adjustment (COLA): Adjusts the value of your monthly DI benefit based on inflation
  • Future increase option (FIO): Allows you to increase your monthly benefit in the future if your income increases, but your premiums will also increase
  • Automatic benefit enhancement (ABE): Automatically increases your benefit each year, for a certain number of years, based on common income increases that a healthy individual can expect
  • Partial or residual disability benefits: Your policy can continue to pay partial benefits after you go back to work if you’ve lost earning power because of your disability

Read more about disability insurance riders you should consider.

What qualifies as a disability?

All DI policies have what’s called a definition of disability, which explains the conditions you must meet in order to qualify for a benefit payment under your specific plan. In general, an injury or illness will qualify you for DI benefits if you are either mentally or physically unable to complete your job, or if you have an impairment that substantially limits your ability to carry out basic life activities.

If you have to self-isolate because of the coronavirus (COVID-19) and you cannot work, you could qualify for disability insurance benefits. Learn more about disability insurance and coronavirus.

Disability insurance exclusions

Disability insurance policies come with riders that specifically exclude certain conditions from qualifying you for benefits. These conditions are called exclusions. Exclusion riders vary by insurance company, but pre-existing conditions are often exclusions. You cannot receive benefits from an excluded condition or from any future conditions that result from an exclusion. The policy will still pay out normally for other illnesses and injuries.

Learn more about disability insurance with a pre-existing condition.

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The types of disability insurance

There are three main kinds of disability insurance: short-term disability insurance (STDI), long-term disability insurance (LTD), and Social Security Disability Insurance (SSDI). Each type of DI provides essentially the same service, but there are differences in the cost of a policy, the benefit period, and where you can apply for a policy. Certain states also offer their own disability benefits.

Short-term disability insuranceLong-term disability insuranceSocial Security Disability Insurance
Benefit period3-6 months2, 5, 10 years, or until retirementAs long as you're disabled
Elimination periodLess than 14 days30-720 days; recommended 90 daysUp to 6 months
Coverage amountUp to 80% gross monthly incomeUp to 60% gross monthly incomePercentage of your income; average $1,258/month
Average costOften included gratis, but sometimes 1%-3% of annual salary1%-3% of annual salaryFree
Where to buyTypically employer-sponsoredIndividual policies available from carriers; employer-sponsoredProvided by the U.S. government

Short-term disability insurance

Employers typically offer short-term disability benefits to employees for free or at a low cost. You can purchase a policy separately but they’re usually prohibitively expensive; it’s around the same cost as a long-term policy despite the difference in benefit periods.

Short-term disability has a waiting period of one or two weeks, and it provides income replacement of up to 80%. Benefits usually last three to six months with a maximum length of around one year. If you ever suffer a long-term disability, a short-term policy will usually expire before a long-term plan kicks in.

Note that some employers provide a short-term disability group plan in place of a maternity leave policy. (Here’s our guide to disability insurance and pregnancy.)

Learn more about short-term disability insurance.

Long-term disability insurance

Long-term disability insurance may be offered through your employer as group coverage, but these plans don’t offer much coverage. More comprehensive plans are available for purchase from an insurance company. Long-term disability benefits can last two years, five years, 10 years, or even until retirement. A policy usually costs about 1% to 3% of your annual income.

LTD insurance may be better for most people than STDI. Benefit payments last longer than short-term disability insurance, it’s easier to qualify for benefits, and a policy provides larger benefits than SSDI.

Learn more about long-term disability insurance.

Social Security Disability Insurance

Social Security Disability Insurance is provided by the federal government through the Social Security Administration (SSA). You can only qualify if you have paid Social Security tax for a certain length of time, but it’s notoriously difficult to qualify for SSDI benefits.

SSDI has a very strict definition of disability — you must be totally disabled, compared to partial or occupational definitions. According to the SSA, more than 70% of all SSDI claims were denied in 2017, and that number has been increasing. Even if you do qualify, it can take nearly two years before you start receiving benefits. Many people also won’t be able to cover their needs because the average monthly SSDI payment is less than $1,300 in 2020. If your total income is more than $25,000 for the year, you may also have to pay tax on your SSDI benefits.

Overall, SSDI is only a safe bet if you can’t afford long-term disability insurance.

State disability insurance

Some states offer their own disability insurance programs, called temporary disability insurance (TDI). These short-term programs are only available through the state, and they’re available in addition to the types of DI explained earlier.

Five states currently offer temporary disability benefits:

  • California
  • Hawaii
  • New Jersey
  • New York
  • Rhode Island

Puerto Rico also offers TDI.

Should you get disability insurance?

Even if you have a short-term policy through your employer, pairing it with a private long-term disability policy will offer the most financial protection for you and anyone who depends on your income to pay the bills.

A 20-year-old worker has a 1 in 4 chance of becoming disabled, for at least one year, by the time they reach retirement age, according to 2017 data from the Social Security Administration. Illness is a more common cause of disability than injury, and illnesses aren’t limited to people with labor-intensive jobs. Losing your income for months in addition to possible medical bills is more than most Americans can handle without going into debt.

Because of how difficult it is to qualify for SSDI, we believe that everyone should consider getting disability insurance. In particular, higher-income earners often have a higher standard of living and their lifestyles would be greatly impacted if they lost income for just a couple of months. Married couples and families typically rely on two incomes to pay all of their bills each month, so losing one could force a choice between which bills to pay. Also consider a DI policy if you have significant debt, whether that’s from a mortgage, an auto loan, or student loan debt from getting an advanced degree.

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About the author

Personal Finance Expert

Derek Silva

Personal Finance Expert

Derek is a tax expert at Policygenius in New York City. He has written about multiple personal finance topics in the past, and his work has been covered by Yahoo Finance, MSN, Business Insider and CNBC.

Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.

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