Most people don’t think they will suffer a debilitating illness or accident.

But here’s a sobering fact:  according to the Social Security Administration, 20-year-olds have a 1 in 4 chance of becoming disabled at some point in their careers before they retire. The resulting impact on their financial security and standard of living can be devastating.

Disability products protect your future earning potential in case you are unable to work. It pays out tax-free monthly cash payments to replace lost income due to a disability.

These options are therefore a key part of a financial plan, and it might be right for you if:

• Other people depend on your income for their standard of living.
• You are accumulating money for a long-term financial goal, like retirement or paying for a child’s education.
• You don’t have the funds to pay for long-term medical care out of your own pocket.
• You have a risky occupation, like a firefighter or police officer, with potentially high rates of injury.
• You have a very specialized occupation, like a surgeon, where you earn substantial amounts of money.

Why Should You buy Disability Insurance?

To illustrate why it is a smart idea to buy disability, consider this example. Let’s say you just bought a brand new $30,000 car with a loan from your bank. Before the bank will give you the money, it requires proof of auto insurance. If you wreck the car, the bank wants to make sure it can get its money back. To keep things simple, let's say auto coverage costs you $1,000 each year.

Most people think it’s wise to pay $1,000 each year to insure a $30,000 car. We think so, too.

Now imagine you are a 30-year-old worker who plans to retire at age 60. You make $50,000 a year as a school teacher. Your total lifetime earning potential over the rest of your career is therefore $1.5 million (30 years x $50,000 = $1,500,000). What if you could buy coverage so that you could be certain you would be able to earn your projected lifetime earnings no matter what happens to you?

That’s exactly what disability products do. If you wreck your car without insurance, you will lose $29,000 (its value minus the savings for not being covered). If you become disabled and can no longer work, you will lose $1,500,000 in future income.

What Kinds are There?

Disability insurance is designed to replace your income in the event you are no longer able to work. But there are many different types of occupations, and as a result there are many different options on the market today. Let’s start with the most essential distinction, related to your occupation.

An own-occupation policy protects you if you can no longer perform the duties associated with your current job. These are the most common policies on the market today. You might still be able to work at a different job, but not at your current role or level. For example, a doctor who loses the fine motor skills to perform intricate surgeries might still be able to work as a cashier in a grocery store. If he or she has an own-occupation policy, the company would pay a benefit even if the insured continues to work. Companies usually define “own-occupation” as any job falling within the same profession, like medicine or law.

Any-occupation policies are relatively cheaper because they offer stricter coverage. They protect against disabilities preventing the insured from working any sort of job whatsoever. If a doctor can no longer perform surgeries but can still work as a cashier, he or she would not be able to make a claim under an any-occupation policy.

There are several components, or policy riders, under both types of disability income policies. It is a complex financial product with different bells and whistles, so let’s break down the most common ones.

• Income benefit: How much money you will get paid on a monthly basis. This is a specific dollar amount that you determine in the application process.

• Catastrophic disability benefit: A separate benefit amount available in the event of a severe disability, defined as losing limbs, becoming blind, or becoming severely mentally impaired.

• Index income benefit: The amount by which your income payment will increase each year (i.e. up to 3%), usually defined by the Consumer Price Index or another generally accepted measure of inflation.

• Future increase benefit: Imagine you buy a policy today, and over the next several years your income increases substantially. The future increase benefit allows you to purchase additional coverage without going through additional underwriting.

As you can imagine, companies offer different “flavors” of these benefits. For example, you might be able to arrange a more or less generous index income benefit depending on your beliefs about future inflation rates.

How do Insurance Companies Define “Disability”?

The precise definitions behind the terms spelled out in your contract are critically important, and none more so than how a company defines the term “disability.”

There are 3 categories.

1. A catastrophic or presumptive disability refers to a condition in which someone’s life is permanently changed. There is no chance for recovery. A catastrophically disabled person needs substantial hands-on assistance to perform the activities of daily living, like bathing, dressing, eating and moving around.

2. A total disability means someone is unable to work at this time, but there is hope for a recovery after enough time and care from a medical professional. For example, a construction worker could claim a total disability while he recovers from throwing out his back. There’s the expectation he will return to work in the future.

3. A partial disability is one that prevents working a current job, but does not prohibit holding any job whatsoever. For instance, a doctor might lose the ability to perform complex surgeries but still deliver lectures to medical students. Professors are paid less than surgeons, resulting in a partial disability.

How Much Does it Cost?

A few different factors determine how much disability products cost. Companies will pay close attention to:

• Your occupational risk: if you have a dangerous job with a high likelihood of becoming injured, expect to pay more for premiums.

• Your age and gender: women are cheaper to insure than men due to professional and personal choices that insurers associate with risk levels, and the older the applicant, the higher the premiums.

• If you are a smoker: smoking cigarettes substantially increases the risk of becoming disabled.

• How much benefit you want: covering $2,000/month in income costs much less than $10,000/month.

• How long you wait to receive benefits: certain policies make you wait some length of time before claiming benefits, i.e. 90 days after you become disabled. The shorter the wait, the more expensive the policy.

• The policy’s occupational class: do you want it in the event you can’t work your own job (more expensive), or any job whatsoever (less expensive)?

How to buy Disability Insurance?

There are five basic steps to buying.

1. Know how much coverage you need and which features you want

Do your homework first before contacting a company about purchasing. Start by figuring out if your employer offers a disability benefit to its workers, and if so, what are the stipulations. This will help you determine how much you should purchase, as well as any features that are important to you. For instance, many companies offer short-term disability insurance, providing a guaranteed 100% of your income for up to 90 days of disability. After 3 months, however, the benefit drops to 60% of your income until age 60. In this situation, look for one to replace 40% of your income after a 90-day waiting period. In other words, you will always maintain 100% of your gross income regardless of which policy you are using.

2. Shop around for a few different quotes

It always pays to shop around. Different providers might offer the exact same options for different prices, and at the very least, it’s important to know you aren’t getting a bad deal with whatever you buy.

Keep in mind that price isn’t the only thing to consider. Think about a company’s reputation for customer service. You don’t want to buy a cheap policy if the company will make you miserable during the underwriting and claims processes. Also put some thought into the financial strength and longevity of your carrier. Startups offering cheap products over the Internet might not be around in 20 years to pay a legitimate claim.

3. Apply

Once you’ve found the right product and company, submit an application. You may need to meet with a financial sales representative to do so, and you should come prepared to answer questions about your personal health, occupation, and income level.

4. Pass the underwriting process

The underwriting process for disability is not as onerous as applying for life insurance. The provider will ask you some questions, either in person or over the phone. They will want to verify your income. You may need to submit saliva for a drug test, but that can take place in the company’s office, not at the doctor’s. They will gather all your data and rate both your personal and occupational risk for disability, and recommend a particular class.

If you believe you qualify as a healthy and low-risk person, and if you’re sure this is the right company, you can make a provisional payment at the time of application. This means that you are covered right away, provided the underwriting results come back as expected.

5. Accept and sign

The company will present you with an underwriting decision and a proposed contract. It’s a straightforward process to either sign the document and schedule regular payments, or reject it (and ask for your initial payment back). In that case, you would have to find another company and start the process over again. If, however, the underwriting results come back as expected, you have just taken a critical step toward a secure financial future.

Frequently Asked Questions

- Can I be covered if I have a pre-existing condition?

In short, maybe. Some pre-existing conditions have very little or no bearing on work performance or future health outcomes. They don’t increase the chances that you will become disabled any more than someone else.

Other pre-existing conditions can become serious obstacles to obtaining coverage. For example, if you have a long history of becoming disabled and you work in a physically demanding environment, providers will likely rate you as too risky to be covered.

- What type should I buy, own-occupation or any-occupation?

Own-occupation policies offer greater protection, but at a higher price. They will pay out if you can’t work your current job anymore, even if you can still hold some other type of employment. Any-occupation policies, on the other hand, are less expensive because they only cover catastrophic situations where you can’t work anywhere.

- What are the odds of becoming disabled?

The Social Security Administration estimates that 20-year-olds have a 1-in-4 chance of becoming disabled in their lifetime. Your specific odds are more difficult to calculate, but the Council for Disability Awareness (CDA) put together a calculator called What’s My Personal Disability Quotient. Keep in mind the CDA is a trade group for disability insurance companies, and its calculator uses the same actuarial tables as its member companies. It will give you an idea of the real world risk of someone like you becoming disabled.