Expert Advice - September 2004

Protecting Your Greatest Asset

With Disability Coverage

by Geoffrey VanderPal

When most people are asked what their most valuable asset is, they respond that their house, car, retirement plan or business is most valuable. I disagree. I believe that your most valuable asset is your ability to earn a living. This is true for just about anyone who is not already retired.

The extent of the risk of a serious injury or illness affecting your ability to earn a living is startling. The probability of a 30-year-old being disabled for more than three months before age 65 is about 50 percent. People in their 40s are three times more likely to be disabled than to die before age 65. Yet a great majority of the population has no disability coverage beyond Social Security and worker’s compensation.

To evaluate your disability income needs, begin with an estimate of the income that will be needed during disability. Once the income need has been established, the resources available should be deducted. The first deduction should be any employer-paid short-term disability or group insurance benefits. Next, you may wish to consider Social Security disability benefits. However, the Social Security system rejects most of the claims made for disability benefits. Finally, reduce the monthly income need by earnings from other sources, such as interest and dividends on investments. The remaining balance is the disability insurance need.

As you might expect, the key to any disability insurance policy is its definition of the term "disabled." There are four key definitions of disability: any occupation, own occupation, reduction in income, and residual. You are disabled under an "any occupation" definition when your condition prevents you from doing anything for anybody that will bring home a paycheck. It is the most restrictive definition.

The "own occupation" definition is far more favorable. Under this definition you are disabled if your condition prevents you from performing the major duties of your occupation. For example, under an "own occupation" policy, a heart surgeon is disabled, even if he could still work as a professor of medicine.

"Income reduction" is a relatively recent innovation. Under these policies, you are disabled as long as your condition forces you to earn less than you were earning before you were sick or injured. How much less you have to earn depends on the policy.

"Residual disability" is also a recent innovation. This definition is an enhancement of an "own occupation" policy. Frequently, a person’s disability may permit him or her to return to a previous occupation, but at reduced hours or duties. In other words, it may take a considerable period of time after return to work to get back to the former level of earnings. The "residual disability" provision is designed to provide benefits to bridge that gap.

Another consideration is taxation on group disability benefits. If your employer pays for the plan, then the benefit paid out in the event of a claim is income-taxable. Conversely, if you pay for disability policy yourself, the benefit is income-tax free. Taxes can severely affect your ability to maintain your standard of living, since disability policies pay up to 66.6 percent of gross earned income. So, a non-taxable benefit is equal to your gross income less one-third in taxes. If you were to receive the 66.6 percent maximum coverage as a taxable benefit, then the net amount is closer to 45 percent of your original gross income before the claim.

Experience has shown that a financial plan that does not include proper disability coverage could greatly jeopardize a person’s retirement, education or business-continuation objectives. Speak to a qualified financial planner or insurance agent regarding your individual needs.

Geoffrey VanderPal
Geoffrey VanderPal MBA, CFP, CFS, RFC is branch manager and financial advisor with Raymond James Financial Services Inc. in Las Vegas.