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Q&A: "What is the Best Strategy for Buying Long Term Disability Insurance? At What Stage in Life Should I Have It?"

Insurance

Question: 

What is the best strategy for buying long term disability insurance? At what stage in life should I have it?

Larry's answer:

I assume you're asking about long-term disability (income) insurance and not long-term care insurance, and will answer accordingly. 

For most people during their working years, their most valuable asset is their own human capital. In other words, their ability to earn an income. Consider for a moment a 30 year old earning $60,000 a year and planning to retire around 65. Their earning capacity is $2.1 million not counting raises or cost-of-living increases. That's a valuable asset worthy of protection. 

So the best stage in life to buy long-term disability income insurance is as early as you need it to protect your earning potential. 

Here are a few thoughts and strategies that might be of help:

  • If LTD insurance is offered through your employer, that will typically cost a lot less than a personal disability policy. But you'll need to be aware of the (significant) differences and limitations of the group policy through your employer vs. a personal policy. Be aware too that if you leave that employer, your group disability insurance terminates.
  • If LTD insurance is offered through your employer, be sure you pay the premium yourself (have it deducted from your pay). Why? When disability insurance premiums are paid by your employer, if you have a qualifying disability the income you receive will be taxable. On the other hand, if you pay the premiums yourself, any disability income you receive will be non-taxable.
  • Tailor your disability income benefit to your actual needs. For some, that means they need to insure the maximum income possible, due to large financial obligations (sole family breadwinner, large debt payments, etc). For others, they may have already accumulated significant assets, paid off their debt, and live well below their current means. So they may need to only insure a portion of their current income (hence reducing the premiums).
  • If you buy a personal disability policy, you'll typically keep the premiums lower by selecting an "elimination period" of 90 days or more. Think of it as kind of like your auto insurance deductible. The policy won't pay until you've had 90 days of disability. Shorter periods are available, but you pay more for them. By implication, that means you need a "rainy day" cash reserve to cover that 90 day elimination period in addition to other unplanned expenses.
  • Think about the benefit period you want to insure. If you're young and still accumulating assets and paying down financial obligations, you'll probably want to insure clear to age 65. On the other hand, if you're already 55 maybe you'll want to keep premium lower by selecting a 5-year benefit period. You may also want to consider the gender factor . . . while the ladies tend to outlive men for life insurance purposes, the men tend not to be on disability claim as long as the ladies. I don't have an answer for why, that's just how it is.
  • Do you need to protect your ability to work in your specific occupation? For example, are you a doctor, dentist, or other professional that has made a huge investment in education and time getting to where you are? If so, you won't want a policy that pays 2 years of disability benefits and then requires you to take any job at which you can earn some sort of income. You'll want to protect your specific occupation and this will typically cost more. Also, I've never seen such occupational protection in standard group LTD contracts offered through an employer, so you'll need a personal disability policy.

There are many other considerations, but hopefully this helps get you started. All the best.

Originally posted on NerdWallet's Ask an Advisor on June 10, 2014.