Why You Can't Rely on Social Security Disability Insurance

By Wendy Connick Markets Fool.com

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Most people would agree on the importance of life insurance, but few of us have even considered buying disability insurance -- though you're more likely to be disabled than to die before your retirement age.

It's true that Social Security offers some disability coverage, but that coverage is pretty limited. First, Social Security has a fairly narrow definition of "disability." According to the Social Security Administration website:

A person is disabled under the Act if he or she can't work due to a severe medical condition that has lasted, or is expected to last, at least one year or result in death. The person's medical condition must prevent him or her from doing work that he or she did in the past, and it must prevent the person from adjusting to other work.

Second, Social Security disability payments are relatively small: For 2015, the average monthly disability benefit was a mere $1,165. That's not much when it's your main source of income.And third, even if you're approved for disability benefits, you won't see a penny until at least six months after the date you become disabled -- if not longer.

Given that one in four 20-year-olds will become disabled before they reach retirement age, private disability insurance is definitely worth looking into.

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Where to get disability insurance

The best place to get disability insurance is almost always with your current employer. Buying insurance through your employer gives you access to a group rate, which will be substantially lower than what you'd pay for an individual policy. The small drawback to an employer-provided plan is that if your employer pays the premiums for the disability policy, then you'll have to pay taxes on the benefits. If you pay the premiums, however, any benefits you receive are tax-free.

If your employer doesn't offer disability insurance, you may be able to find a group rate somewhere else. Unions and trade associations are great places to start looking for such a plan. The amount you'd save on a disability policy alone may be enough to pay for any membership fees. Try googling your job title followed by the words "trade association," and you'll likely get several hits.

Self-employed types should seriously consider becoming members of the Freelancers Union, which is free to join and has a group disability policy with plenty of options. In my own case, the search for individual disability policies yielded quotes of around $300-$400 per month, while the Freelancers Union disability policy quoted me less than one-tenth that amount.

What disability insurance can do for you

Disability insurance policies generally come with a plethora of options. You'll have to decide how much of a waiting period to accept before the benefits kick in (typical options are 30 days and 90 days) and how large you want the monthly benefit to be (most policies will restrict you to a maximum of 60% of your current monthly income). You may also get a choice of how long you'll receive benefits, whether for just a few years or until you reach age 65. And some carriers offer two different classes of disability policies: one that will kick in if you become disabled in such a way that you can't do your current job, and another that will only kick in if you become disabled in a way that keeps you from doing any job.

When choosing a waiting period, there are several factors to consider. First, how big is your emergency savings account? If you have the recommended three to six months' worth of expenses saved, you can feel pretty safe about choosing a 90-day waiting period. Naturally, going with a longer waiting period means a smaller monthly premium. Some states also offer short-term disability benefits; if you live in such a state and are eligible, then these short-term benefits can take care of your expenses during the waiting period before your private disability insurance kicks in.

Choosing a benefit period of, say, two or four years will obviously yield a much smaller premium payment then a benefit period that protects for decades. However, think long and hard before you go with a short-term benefit period. If you become seriously disabled, it's unlikely you'll be fully healed within a couple of years. Unless you truly can't afford the higher premiums, stick with a policy that will protect you until retirement age.

Then there's own-occupation coverage, which will pay benefits as long as you are too disabled to do your current job (i.e., your "own occupation"). It's pricier than general-purpose disability insurance, but most people will want to stick with own-occupation coverage if it's an option. Check the fine print in your policy to see exactly how it defines "too disabled to work" before you make a final decision.

The final factor to consider when buying any insurance policy is whether the insurer will still be around to pay your benefits when you're ready to collect them. To be safe, stick with insurance companies with the highest A.M. Best financial strength ratings and credit ratings. That gives you a pretty durable financial umbrella to hoist against the proverbial rainy day.

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