Personal Finance Essentials

A Warning About DI Insurance Provided by Your Employer

Disability Income Insurance > A Warning About DI Insurance Provided by Your Employer

Many employers provide disability income insurance to their workers, and most employees who have DI coverage get it this way.

It’s convenient, and it’s often free. But group DI coverage comes with serious limitations that aren’t always obvious until it’s too late to do anything about them.

Here are the key problems with employer-provided DI coverage:

The definition of disability in a group policy is often far more restrictive than what you’d find in an individual policy.
Your employer can cancel the coverage at any time.
The insurance company can also change or cancel the benefit.
If you leave your employer – voluntarily or otherwise – you lose the coverage.
The cost of coverage to you can increase.

The Tax Problem with Employer-Paid Premiums

Here’s the problem that catches most people off guard: if your employer pays the DI premium on your behalf, the benefits you receive become taxable income. The benefit amount is still limited to about 60% of your pay – but now you owe income tax on that amount. After paying roughly 20% in taxes, you’re left with only 40% of your pre-disability income. Can you live on 40% of what you currently earn?

If the answer is no, you need to buy a supplemental policy on your own to cover the gap. The good news is that you may only need to replace the 20% lost to taxes – which means the supplemental policy may not cost as much as you’d expect.

Two Groups Who Especially Need Their Own Policy

Two groups of workers face additional risks with employer-provided DI coverage and should strongly consider purchasing their own non-cancellable policy before the situation changes.

Group 1: Anyone planning to leave the workforce temporarily

For example, a professional who intends to stop working for a few years to raise children. Once you leave your job, the employer-provided DI coverage is gone. And obtaining a new individual policy after you’ve left the workforce is difficult: you need a paycheck to qualify for coverage, and pregnancy is typically treated as a pre-existing condition. The solution is to purchase your own non-cancellable policy before leaving. Once owned, that policy stays with you regardless of your employment status, and it moves with you if you later return to work in a different occupation.

Group 2: Anyone planning to become self-employed

Once you leave steady employment to start a business or consulting practice, insurance companies will want to verify a stable, established source of income before issuing a DI policy. With a brand-new business, that income is often zero – and you may not be eligible for coverage for at least two years. The solution is the same: buy your own non-cancellable policy long before you make the move.

For all of these reasons, it’s often smarter to buy your own DI policy – even if you have employer-provided coverage. Shop independently and compare.

Don’t Buy the Return of Premium Rider

Some insurers offer what’s called a Return of Premium Rider as an add-on to your DI policy. This rider promises a partial refund – typically 50% – of the premiums you’ve paid if you never become disabled. The pitch sounds appealing: buy coverage, and if you’re lucky enough never to need it, you’ll get some money back.

It’s a bad deal. Adding this rider increases the cost of your policy by 20% to 40% – and all it does is give you a shot at recovering half your premiums. That means you’re paying a significant extra amount for the possibility of getting back a smaller amount. The math doesn’t favor the consumer.

There’s also a logical contradiction at the heart of the rider. You buy a DI policy because you might become disabled. You add the Return of Premium Rider because you believe you won’t. Those two beliefs are in direct conflict – and one of them is wrong. The best approach is simply to buy the insurance and hope you never need to use it. That’s exactly what insurance is for.

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