What is disability insurance and how does it work?
Understand your coverage options when you’re unable to work after becoming hurt or sick.
While many might think their chances of becoming disabled are slim, the reality is that more than one in four adults in the United States have a disability, according to the Centers for Disease Control and Prevention (CDC). Given this statistic, you may want to consider extra precautions. One way to do so is to obtain disability insurance coverage which may help protect your financial well-being in case of an emergency.
The causes of disability are as diverse as their duration: For example, Short-term disability for an injury that requires a hospital stay, or Long-term disability for recovery from an accident or debilitating illness. Whatever the cause or length, a disability has the potential to cause a financial crisis in your household. Here’s what to know about the financial impact of disabilities and what you can do to help protect yourself.
What is disability insurance?
While health insurance is there to help cover medical bills, disability insurance is meant to help provide coverage for part of an employee’s missing income when they’re unable to work due to an illness or disabling injury. Disability insurance can help provide benefits that cover 50 to 60% of an employee's salary on average.
How does disability insurance work?
Usually, disability insurance is an agreement between you (the policyholder) and an insurance company. You make monthly payments and, in the case that you suffer a disability that leaves you unable to work, the insurance company agrees to pay you a monthly amount. The policy will explain details like the monthly premium, what is or isn’t covered and limitations (like performing other types of work), the monthly benefit amount and the length of the benefit.
Types of disability insurance
There are two basic types of individual policies: Short-term disability and Long-term disability.
- Short-term disability insurance — provides funds to help with monthly expenses like car loans, mortgage, rent and credit cards or to help replace lost income if you become disabled.
- Long-term disability insurance — provides funds to help replace lost income if you become disabled for an extended period of time.
Benefits and options for short and long-term disability insurance
- Short-term disability has a one- or three-year benefit period and may help replace a portion of your monthly income up to a maximum of $3,000, based upon your income.
- Long-term disability has a five-year benefit period, or a "to age 67" benefit option and may help replace a portion of your monthly income up to a maximum of $20,000, based upon your occupation and income. As part of this policy, you may want to consider optional riders:
- A cost-of-living adjustment (COLA) benefit to help protect against inflation by increasing your monthly disability payments each year.
- Residual disability riders that continue to pay out in reduced amounts if you're able to work part-time.
- Accidental death and dismemberment (AD&D) gives a lump-sum payment in the event of death or severe injury, such as the loss of a limb or sight, due to an accident.
- Social Insurance Supplement Rider (SIS) provides an additional benefit amount. Your disability benefit amount will be reduced proportionally once the SIS benefit is approved.
- Five Year and to Age 67 Own-Occupation options which changes the qualification of a claim so it's specific to your occupation (if you can do another job, you would still get the benefit).
Social Security Disability Insurance
Social Security Disability Insurance is the government-sponsored form of disability insurance that’s paid for by Social Security taxes. As such, tax-paying U.S. citizens are automatically able to apply for it without an additional recurring cost. Similar to other policies, it helps provide income for living expenses should you become disabled, but notably requires extensive proof of the disability and a track record of many years of work, among many other requirements.
Do you need disability insurance?
The Council for Disability Income Awareness (CDIA) states that just over one in four of today’s 20-year-olds will become disabled before they retire. Most Americans are nowhere near prepared to face a year without paychecks. According to a study by the Federal Reserve, 37% of U.S. adults couldn’t cover an emergency expense of just $400 without going into debt, paying it off over time, assuming a loan, borrowing from friends or family or selling off possessions.
Things to consider for disability insurance
While Social Security Disability Insurance and disability insurance offered by your employer may be convenient in various ways, there are some downsides that may make individual disability insurance more enticing.
Bankruptcy due to medical bills
One of the reasons for personal bankruptcy filing in the U.S is due to medical bills. A survey done by affordablehealthinsurance.com in 2022 found the following U.S. statistics:
- 56% of adults in America had some type of medical debt.
- 1 of every 4 individuals with medical debt, owed at least $10,000.
- 44% of people had medical debt related to emergency room services.
- At least 14% of people with medical debt considered filing bankruptcy.
- Almost half (46%) of Americans with medical debt had to delay their home purchase.
Considerations for Social Security Disability Insurance
The Social Security Administration states that a successful Social Security Disability Insurance claim can mean a long stretch without income, as claims generally take six to eight months for an initial decision. As of December 2023, the average disabled worker benefit is about $1,470 a month (which, annually, is well below the poverty line for a two-person household.)
The extended waiting period is due in part to the stringent requirements and documented proof that Social Security requires to start offering benefits. While individual plans may only require an applicant to prove that they can’t participate in the same line of work anymore, Social Security Disability Insurance applicants must prove that their disability is severe enough to prevent them from participating in any type of meaningful work. For a full list of requirements, you can reference the Social Security website.
Considerations for employer disability insurance
Work-based disability insurance can be convenient to purchase and reasonable in cost. The downside: The coverage may not be transferable, and you may have to forfeit it if you change jobs. It also may not be available to you. According to americanprogress.org, about 57% of workers in the private sector do not have access to short-term disability.
Considerations for individual disability insurance
An individual disability insurance policy may have more flexibility and give you more options. It stays in place no matter how often you change jobs, and you can choose the time period you want coverage in place. Additionally, depending on your plan and your financial situation, benefits may be higher than Social Security and you may have a shorter waiting period before you begin receiving benefits.
Disability insurance for the self-employed
Planning, strategizing and mitigating risk is especially important when you have a business and are self-employed. Disability insurance is a particularly important tool to help mitigate risk for people who own small businesses and are self-employed. Disability insurance may help protect the business, too.
What to look for in a disability policy
When shopping for an individual disability policy, consider the following:
- Company financial strength — pick an insurance provider that is financially stable and has a solid track record of honoring claims when needed.
- Definition of disability — look for policies with the most inclusive definition of disability. Try to find a policy that allows you to collect benefits even if you can work in another occupation, depending on your skills and background.
- Partial or residual benefits — if you’re only able to work part-time or if your income decreases by a certain percentage due to a disability, some policies may offer partial or residual benefits. This feature may help provide financial support even when you're partially disabled.
- Waiting period (elimination period) — consider how long you need to wait before benefits start, as this can vary from 30 to 360 days. The longer the waiting period, the lower the premiums, but it’s important to choose a period that aligns with your financial situation and access to emergency funds.
- Benefit period — assess how long you need coverage. Some policies offer short-term coverage, while others extend to long-term or even lifetime benefits. Select a benefit period that matches your financial protection goals.
- Inflation protection — look for policies that adjust benefit payments over time to help keep pace with inflation.
- Cost-of-living adjustments — some policies include a cost-of-living adjustment, which increases benefit amounts after a disability occurs, helping you maintain your standard of living.
- Policy renewability and cancelability — try to find a policy that is either noncancelable or guaranteed renewable. A noncancelable policy means the insurer can’t change terms or increase premiums as long as you pay on time. A guaranteed renewable policy makes it so you can renew regardless of the circumstances, though premiums may rise. Not all policies are available in every state.
Talk to your State Farm® agent about how to coordinate short- and long-term policies, how to help protect your income and other financial obligations you may need to cover if a disabling injury or sickness occurs.