How to Protect Your Income

You spend so much time worrying about how to grow your savings, but how do you protect your income that helped grow those savings?

I wrote here how insurance plays a major role in your financial plan.

This post will dive deeper into an often-underutilized type of insurance that protects the income you work so hard for, disability insurance.

What is Disability Insurance

Disability insurance is in many ways the exact opposite of life insurance.

It is an insurance you pay a premium for to receive a benefit if you are still living and unable to work.

A Case Study

Let’s walk through an example.

Mary a healthy 45-year-old. She makes about $150,000 a year and is married and has three kids. Her spouse, Mark, also works and makes about $100,000 a year.

Through their income Mary and Mark bought dream house and still have a mortgage. The mortgage will be paid off in 20 years when they plan to retire at 65.

Unfortunately, Mary was in a car accident and is no longer able to perform her job as an engineer.

She fortunately has a disability policy through work. However, it only covers 60% of her current income, or $90,000.

That is also before tax, so now she is looking at about $68,000 annually after tax each year.

Let’s see how Mary and Mark could have utilized disability insurance to protect their income and the life they have built.

Types of Disability Insurance

Mark and Mary unfortunately left themselves unprotected by not purchasing more disability insurance.

The coverage Mary had at work is nice but limited. Let’s dive into that coverage.

Group or Work Coverage

Group coverage or sometimes called work coverage in a disability insurance benefit you receive as part of your benefits package.

It is often very cheap – a few dollars a paycheck. And is a good first step in protecting yourself.

Workers can often purchase another 10-20% coverage for a few more dollars a month as well.

There are some drawbacks to it as well.

The first is that the benefit you receive is likely taxable. You may be able to purchase up to 80% coverage but after accounting for taxes Mary likely would have had somewhere between $80-90k annually from this policy.

Now I know what you’re thinking this is not all that bad. And I agree – Mary and Mark are probably pretty close to where they were before the accident.

But there is one big hang up with work disability insurance. Any-occupation coverage.

The way any-occupation coverage works is pretty simple. After a certain period of time, normally 2 years, the insurance company will go to Mary and ask “can you do any type of job?”

Mary, unable to be an engineer anymore because of the physical aspect of the job, will likely answer yes.

But she will also tell them she will not be able to be an engineer in the same capacity she was before. The insurance company will ask “what type of job can you do?”

Mary might tell them that she is able to work in the back office in a job that pays $75,000 a year.

The insurance company will then say “great, you take that job, and your benefits will cease once you do.”

Now that is a simple example but often what happens. Now Mary is likely to make half of what she made previously for the rest of her life.

She may not be able to continue to afford the same lifestyle she had before.

This is where an individual policy would have come in handy.

Individual Disability Insurance

Individual disability insurance is a policy you buy outside of work.

It is often more expensive than your work policy, but with good reason.

Its benefits are often non-taxable. The insured can purchase more in the future if needed through a Future Purchase Option (FPO).

And the best part is that it will likely have “own-occupation coverage.”

First let’s talk about the non-taxable benefit. Let’s say Mary had 60% coverage through work. After tax she would roughly $68,000 a year to spend.

She could purchase and individual policy for another $82,000 of coverage for a few thousand dollars a year to make up the difference.

That $82k would be non-taxable and would be hers free and clear.

The next way an individual policy could have helped Mary is through its “own-occupation” coverage.

When the insurance company comes to Mary in a few years and asks if she can perform any job and she answers yes, she would not lose the benefit of the individual policy.

This is because she is no longer able to perform her own occupation. This is the key difference between individual policies and work policies.

She would have been able to take the job in the back office for $75,000 and still received her benefits in the individual policy because she passes the “own-occupation” standard.

Finally let’s operate under the assumption that Mary might not want to do the back-office job.

She could have put a FPO rider on her policy to extend her coverage to the $150k she made previously.

For a few more dollars a month she could have extended here coverage. When the work policy stopped the FPO would have been enacted and paid her a higher benefit amount.

All of her income would have been replaced and she would not have had to work at all.

Her goals and Mark’s goals would have remained intact. From a financial standpoint everything would have been the same.

That is the power of disability insurance.

This article on NerdWallet is a great follow up to this article.

Take a peak at it to learn even more about coverage.

Mary and Mark Now

We looked at everything from Mary’s perspective. In reality Mark needs covered as well.

When applying for disability insurance it is important that everyone in a household is covered.

Had I met with Mary and Mark we would have found this need in one of the first steps of a financial plan.

Protection is more important that growth as you accumulate more. It provides you with an income if something unexpected happens. This allows you to maintain the same standard of living.

Next Steps

I urge you to look at your own disability coverage.

Start at work and read all the terms. If you find you have a shortfall you need to buy more coverage.

If you are looking and need more guidance, please reach out to me for some help.

This is such a simple step to take that can help you have peace of mind from events outside of your control.

How are you insuring yourself if you are unable to work?