For millennials, long-term disability insurance might be the most important decision in their life. The average 25-year-old has $1.75 million in human capital to protect. I outline the various sources of income you can receive if you become disabled and how to protect yourself by getting an appropriate amount of coverage.
Depending on what your income was before a disability, government plans may only pay a small portion of your previous income. It also may be more difficult to meet their tests for disability than a group or private disability insurance plan and can be restrictive when determining financial need.
When looking at group and private disability insurance plans there are two key definitions. The first is “any occupation”. An any occupation plan means that you are considered disabled if you are unable to work at any occupation for which you are qualified by education, training, or experience. This could lead you to be denied benefits if you cannot work in the particular job you had prior to the disability, but could still work in another reasonable job, typically earning at least 50-60% of your previous income.
On the other hand, if you have “own occupation” insurance, you have to be able to return to the same job as before. Otherwise, your benefits, or at least a portion of them, will continue to be paid.
The higher the income you earn, and the more specialized your position, the higher the need for own occupation insurance to maintain your current income and lifestyle.
There are many variations of coverage when it comes group disability insurance plans. Many will offer own occupation disability coverage for the first two years, then any occupation coverage thereafter.
Most disability plans will also include integration of benefits. This means that if you receive benefits under CPP, worker’s compensation, part-time income, etc. the insurance company will reduce their payments so that you are only eligible for a maximum total income. This maximum might be the amount of disability coverage under the plan or it might be 70 or 85% of your pre-disability income. Since each plan is different, you’ll need to determine what the restrictions are with any plan you currently have or are considering. The main reason behind these maximums are so that you are never in a better position financially with a disability than prior to the disability (insurance companies want to encourage you to get better and stop your disability insurance payments).
The best way to do this is to refer to the budget I discussed in my making informed decisions video. Essentially, you want to determine your main expenses and make sure you can cover those if you were unable to work due to a disability. To be safe, you’ll want to also consider the amount of savings you’ll need to continue put away for retirement. Most disability insurance plans stop at age 65, so if you become disabled early and don’t recover, your retirement savings may be insufficient. Also, not incorporating retirement savings puts more pressure on future you to make up the difference, including compound returns. Let’s say you need $6,000 per month after-tax to cover your expenses and savings.
Let’s say you have group coverage for $4,000 / month. Your coverage is own occupation for the first 2 years, then any occupation thereafter. When it comes to group coverage, you need to figure out whether that $4,000 benefit is taxable, or tax-free. If your employer pays for the regular premium, it will be taxable. In Ontario, the after-tax value of this disability benefit would be about $3,300. If you pay for the premium, even if it’s automatically deducted from your paycheque, it will be tax free, so you receive the full $4,000. For this example, we’ll assume you pay for the disability insurance so you receive $4,000 in after-tax disability payments.
Since your group plan will pay $4,000 per month, and your have cash outflows of $6,000 per month, you have a shortfall of $2,000 each month if you were to become disabled. You can either reassess your expenses, or more realistically, get private insurance that will cover the difference. You can also look at getting private insurance so that you are covered for own occupation after the 2-year limit on the group plan.
There is often a waiting period for long-term disability – 90 or 120 days for example. A short-term disability plan and EI sickness benefits may cover some or all your expenses during this time. However, it may take some time to process the disability paperwork and be paid by these plans, so if you have a 3 to 6-month emergency fund, that will cover your expenses during the long-term disability waiting benefit.
