Personal Finance Essentials
DI Insurance Cost and Coverage
There’s no getting around it: disability income insurance is expensive.
Annual premiums can range from 1% to 3% of your annual salary. For some occupations and benefit structures, it can run as high as 5%. Many people look at that number and decide they can’t afford it.
But turn that argument around. The reason DI coverage is expensive is the same reason you need it – because there is a very real likelihood that you’ll need to file a claim. Insurance companies know this, and they price accordingly. The higher the probability of a claim, the higher the cost of coverage. When a company tells you that DI premiums are high, they’re really telling you how important the protection is.
Consider this comparison: a 40-year-old earning $75,000 a year who owns a $500,000 life insurance policy and a DI policy paying 60% of her salary to age 65. If she dies, the insurance company pays $500,000. But if she becomes disabled, the insurer would pay $45,000 per year for 30 years – a total of $1,125,000. That’s why disability insurance costs more than life insurance. And that’s why you need it.
Why You Won’t Get 100% of Your Paycheck
When you file a claim under a DI policy, you won’t receive your full salary. The industry standard is approximately 60% of your pay. This isn’t an arbitrary limitation – it’s based on tax treatment. Disability insurance benefits are tax-free under federal law when you pay the premiums yourself. Receiving 60 cents tax-free is effectively the same as receiving a dollar that is subject to income tax. So, while 60% sounds like less, it’s structured to approximate your true take-home pay.
The Tax Issue for Business Owners and the Self-Employed
If you own a business, you may be tempted to deduct the cost of your DI policy as a business expense – which would give you a tax write-off and lower your net cost. Don’t do it.
Here’s why: if your premiums are treated as a business expense, any disability income benefits you later receive become taxable income. You’ll lose a portion of the benefit to taxes at the very time you can least afford it. Pay for the policy personally, out of your own pocket, with no tax deduction. That way, if you ever need to file a claim, the benefits you receive will be entirely tax-free.
Never Buy a Cheap DI Policy
With life insurance, shopping for the lowest price is often a perfectly reasonable strategy. With disability income insurance, it’s a mistake. The cheaper the policy, the less likely it will pay a claim – and if it does pay, the less it will pay.
The reason comes back to how disability is defined in the contract. Cheap policies use strict, narrow definitions that are hard to satisfy. More expensive policies use broader definitions that are more likely to result in a paid claim. When you’re comparing policies, don’t lead with cost. Lead with the definition of disability and work from there.