What is Disability Insurance?

Disability Insurance provides you with an income stream should you become disabled and unable to work. It has nothing to do with whether you are injured at work or not – you could be at home, slip in the tub on a Saturday night and break your leg – you would be covered so long as you met the condition of “disabled” as listed in your policy.

For the average 30 year old, the often quoted statistic is that there is a 1 in 3 chance they they will have a disability lasting 3 months or longer, with the average disability lasting 32 months. I’ve talked about how important it is since your ability to earn an income is your most important asset – especially when you are young.

Let’s look at a 25 year old, fresh out of University and earning $50,000 in their first job.  If we assume a 3% increase in salary every year until age 65, then this person stands to earn $3.7 million dollars over the course of his/her career. Let’s call it $2.5 million after tax. That’s a lot of money.

Most often, your employer will offer disability insurance as part of your benefits package and you will probably be covered for 60% of your GROSS income (before tax). Now, that 60% is almost always tax free. Let’s look at an example.

Joe earns $50,000. His after tax income would be $39,841 which works out to $3,320.08 per month (after tax).  If Joe were to become disabled, then he would receive 60% of his gross salary.  In which case, 60% x $50,000 / 12 = $2,500 per month. But that amount is tax free.  So he still has a shortfall of $820.08 per month ($3,320.08 – $2,500) – just enough of an incentive to make him WANT to go back to work.

When you have coverage through your work – you should be careful to check what your coverage is – more often than not people assume that all coverage is the same.  IT IS NOT! Usually the benefit period is “Until age 65″ but sometimes it’s only 5 years! If you were to become disabled at age 30…. well, I don’t even need to explain that, do I?

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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