In our “Ask a CFP” Q&A series, we cede the floor to a Certified Financial Planner™ who will address what we think are some of the trickiest money topics out there.
When most people think about their basic insurance needs, typically life, health, homeowner’s and auto insurance policies are what come to mind.
What might surprise them, however, is the importance of disability insurance.
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It can help replace a portion of your income in the event that a medical issue prevents you from working, but people seldom believe that they’d ever become so sick or injured that they couldn’t earn a living.
Knowing the chances that you could become disabled, however, can help give you some perspective on why it’s important to have this type of insurance.
That’s where a personal disability quotient—also known as PDQ—comes into play.
Today, Tom Gilmour, CFP, a financial planner with LearnVest Planning Services, explains why knowing your PDQ can help you to better protect your income.
Why You Want This Type of Insurance On Your Radar
A lot of young, healthy people, in particular, don’t think that they could become disabled.
But the stats tell a different story: The Social Security Administration estimates that a 20-year-old entering the workforce has a one in four chance of becoming disabled before retirement.
Lifestyle and health factors can raise or lower that probability, and the Council for Disability Awareness’s PDQ calculator can help you determine the odds that you’ll become disabled, based on factors like how active you are and whether you smoke or have a condition like diabetes or high blood pressure.
For instance, the calculator shows that a healthy 35-year-old woman who is 5 foot 4, weighs 125 pounds, doesn’t smoke, and has a sedentary office job has an 18% chance of becoming disabled for three or more months at some point during her career.
If she does become disabled for three months, she has a 38% chance of that disability lasting five or more years—with the average length of a long-term disability for someone in her demo clocking in at 82 months.
That’s nearly seven years when she may not be able to work—and a period of time when disability insurance could help make up for some of her lost income.
Adding Income to the Equation
Once you’ve figured out your PDQ, another important number to know is your EIQ, or earnable income quotient.
This number tells you how much income you stand to earn between now and your expected retirement age, which you can calculate here. Determining your EIQ can help further show what’s really at stake should you become disabled.
For example, if that same 35-year-old woman made $50,000 today, received a nominal 3% raise every year and wanted to retire at age 67, she would earn more than $2.6 million over the course of her career.
Now imagine the hit that number could take if she couldn’t work for several years.
So, in my opinion, if you earn an income, you should consider getting disability insurance.
You can start by looking into whether your employer offers it. This is usually a cheaper way to purchase coverage because you’re getting a group discount.
But sometimes that may not be enough.
A typical employer plan covers about 60% of your income. But if your employer pays all or part of the premiums, then any disability payouts you receive that can be attributed to their contribution count as taxable income—so your actual benefit could be closer to 50%, or even less, after taxes.
Also, your employer’s disability insurance may cover only your base salary. If you receive a good chunk of your pay in the form of commissions or bonuses, that money may not be factored in to the 60% calculation.
For added protection, you may want to also think about getting supplemental private disability insurance, which could enable you to replace closer to 85% of your income.
Companies that sell life insurance frequently also sell disability insurance, and there are two kinds of coverage: short-term and long-term.
Short-term disability coverage typically kicks in after a week or so of a person’s being out of work, and could provide benefits anywhere from a few weeks up to a year.
Long-term coverage typically goes into effect after three to six months with a disability—and could provide benefits from a few years through to retirement age, depending on the policy.
The Bottom Line
There’s a lot that could happen to you health-wise before you retire. Calculating your PDQ and EIQ can help you see why it’s advisable to protect one of your most important assets—your income—with disability insurance.”
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. LearnVest, Inc., is wholly owned by NM Planning, LLC, a subsidiary of The Northwestern Mutual Life Insurance Company. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.