Life Insurance Basics
If an individual becomes too ill or disabled to work, disability insurance offers regular benefit payments so they don’t have to go without an income. There are several types of disability insurance — some provided by an employer, some an individual can purchase independently — and they all offer slightly different coverage and benefits for different situations.
The two main types of disability insurance are long- and short-term policies. However, long-term disability insurance is generally the best type of disability insurance for most people because it is the most cost-effective and offers the most comprehensive coverage.
Long-term disability insurance
Long-term disability insurance pays out monthly benefits if an individual becomes too ill or disabled to work. The benefit period can last two, five, or 10 years, or even until retirement, and the monthly benefit is up to 60% of the individual's gross monthly income. It generally costs about 1% to 3% of an individual's salary.
According to Policygenius data, the average length of a long-term disability for someone in their 30s is a little under three years. Because of this, long-term disability insurance provides the most robust protection if an individual becomes disabled when compared to other types of disability insurance that pay out benefits for a shorter period.
Types of long-term disability insurance
There are two types of long-term disability insurance policies:
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Any-occupation disability insurance: Only pays benefits if an individual can’t work any job that they're reasonably suited for because of illness or injury. This is much harder to prove and it’s harder to receive a benefit, but it’s also generally less expensive than own-occupation disability insurance.
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Own-occupation disability insurance: Defines a disability as an inability to work at an individual's regular occupation and will pay out even if they can work another job.
There are also three kinds of own-occupation disability insurance policies:
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True own-occupation: If an individual can’t work in their own occupation due to injury or illness, they get benefits even if they start working a different job.
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Transitional own-occupation: If an individual can’t work in their own occupation due to injury or illness and they get a new job that provides a lower salary, they get benefits to make up the difference between their new (lower) and old (higher) salaries.
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Own-occupation, not engaged: If an individual can’t work in their own occupation and they haven’t started a new job, they get benefits. Once they start a new job, no matter what field, they stop receiving benefits.
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Short-term disability insurance
Like long-term disability insurance, short-term disability insurance replaces up to 60% of an individual's pre-tax income if they can’t work due to an illness or injury. The difference, however, is that coverage only lasts for up to one year.
Short-term disability policies are often offered by an individual's employer (group disability insurance), and some states require that employers provide short-term disability coverage.
Because the average disability lasts about three years, short-term disability insurance policies shouldn’t be bought in lieu of a long-term disability plan. Instead, they are a good supplement to long-term policies because they have a drastically shorter elimination period that can be just a few days. An individual can use a short-term policy to cover living expenses while they wait for your long-term policy to become active.
Short-term policies are also the same cost as long-term disability policies, but because coverage isn’t as comprehensive it’s not a very cost-effective choice.
Mortgage disability insurance
Mortgage disability insurance — also known as mortgage payment protection insurance — is a type of long-term disability insurance that specifically covers an individual's mortgage payments if they can’t work due to an illness or injury.
Mortgage disability insurance can be purchased from a mortgage lender, an insurance agency, or a broker, and doesn’t require the typical underwriting process or medical exam that other long-term disability insurance policies do. It’s a good alternative if an individual cannot qualify for regular long-term disability coverage but they don’t want to risk defaulting on their mortgage.
Supplemental disability insurance
Supplemental disability insurance closes the gap between the benefits paid by employer-sponsored disability plans (which can be taxed or capped), and the full amount of money an individual will need to cover their expenses in case their can’t work.
Social Security disability insurance
Social Security disability insurance (SSDI) is a federal program that provides payouts to some disabled U.S. workers and families, but only after a drawn-out application process that can take three to five months. Over 60% of applications are denied at the first application level and the average payout is just over $1,000 a month, so it’s not worth relying on. Most people are better off with a private disability policy.
State disability insurance
Some states offer their own short-term disability insurance plans that either employers pay for, employees pay for through payroll deductions, or a mix of both. The following states (and U.S. territory) offer state disability insurance, also known as temporary disability insurance:
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California
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Hawaii
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New Jersey
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New York
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Rhode Island
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Puerto Rico
An individual cannot purchase state insurance benefits through an agent or broker, and benefits aren’t generally payable for more than one year.
Because state disability insurance benefits are short-term, an individual will get the most protection by purchasing a long-term disability insurance policy even if they have state disability insurance.
Workers’ compensation
Workers’ compensation, also known as workers comp, is a type of insurance that an individual's employer is required to have in every state that pays out if they become injured at work. Many people assume that workers comp is a substitute for disability insurance, but it offers much less coverage. Workers’ comp does pay out a monthly benefit in the event an employee cannot work, but only if the employee’s injury happened at work.
Disability overhead expense insurance
Disability overhead expense insurance is a type of disability insurance specifically for business owners that will pay for a business’s overhead — including rent, utilities, employee salaries, payroll taxes, postage, accounting fees, and more — if a business owner becomes ill or disabled and can’t run their business.
Disability overhead expense insurance needs to be bought in addition to a long-term disability policy, as it will not cover the loss of a business owner's own salary and expenses.
Alternatives to disability insurance
One alternative to disability insurance is a form of self-insurance. Self-insurance is not actually insurance but refers to using one's savings to fulfill their financial needs. Some people use savings to replace their income in the event of an illness or disability, but this risks depleting funds one might need in the future.
More than 50% of adults don’t have enough money saved to cover an emergency, so for most people, this is not an option.