I’ve talked on the blog about the vital role life insurance can play in your financial picture, but I haven’t specifically talked about disability insurance. Today I’m fixing that! Super exciting right?! I know how much we all love chatting about insurance. The thing is, life insurance is important. But when you are just starting out and haven’t built up a lot of assets, then disability insurance is likely even more critical.
What Is Disability Insurance?
Life insurance is there for your family when you die, but disability is there for you when you get hurt. It will step in and provide you with money when you are unable to work and receive your regular paycheque.
Think for a minute about what would happen if you were injured and couldn’t work? Obviously, your finances would suffer. You might not be able to pay your rent, buy groceries, or do any of the other fun things that make up your current lifestyle.
This is a big deal for people who haven’t had the opportunity to build up a decent cushion to weather that kind of storm. And that’s why you need disability insurance. If losing your income for any amount of time is going to be a real struggle, then this post is for you. And really, that’s most of us.
Check Your Work Benefits
If you have benefits through your employer, then there is a chance you already have disability insurance coverage. Go read that package buried in the bottom of your desk. When I look through my package I can see that I have long-term disability coverage that would kick in (if approved) after 119 days. It would replace 66.67% of my first $2,250 of monthly income and 50% of anything above that. It would still result in a reduction of my income by 66.67% is better than 0%. It’s also fairly typical. Most disability plans (especially employer-provided) will be in the 60% to 70% range.
Long Term Disability Insurance
You might have noticed that my coverage wouldn’t kick in until I was off work for 119 days. That’s how long-term disability insurance works. It is meant for long-term or permanent injuries and illnesses and not things that will keep you off work for a shorter period. Those 119 days are called the elimination period. Basically, the insurance company is waiting to see if you get better before they start paying you. Once your claim is approved and your elimination period is over, you will begin to receive payments.
CPP Disability Benefit
In certain situations, you may also be able to apply for the CPP Disability Benefit. This works like disability insurance, but you have to meet more specific criteria. To be eligible for a CPP disability pension, you have to have a ‘severe and prolonged‘ disability that prevents you from doing ANY job. You also must be under 65 and have contributed to CPP in four of the last six years.
Short Term Disability Insurance
Short term disability insurance is meant to cover that gap during the elimination period. It’s not as common because it is easier to cover an income loss for 4-6 months than it is to cover it for, potentially, the rest of your working life. There are, however, a few options that can cover you during this time.
EI Sickness Benefit
In Canada, most of us have heard of employment insurance (EI). A portion of your paycheque goes to EI, and you will receive replacement income if you lose your job. What you might not know is that the EI Sickness Benefit can act as short term disability insurance if you are unable to work because of sickness, injury, or quarantine. To be eligible, you have to pay into the program, have your earnings reduced by more than 40% and have accumulated at least 600 hours of insurable employment in the last year. EI benefits usually cover 55% of your income up to a maximum of $562 per week and can be paid for a maximum period of 15 weeks. For me, that would take me pretty close to the 119 day elimination period when my long-term disability program would kick in.
If you have a fully-funded emergency fund with 3-6 months of living expenses, then this will hopefully get you through a short-term disability situation. Self-insuring with your e-fund might not sound like much fun, but it is often cheaper than paying insurance premiums for years.
Do You Have Enough Coverage?
Only you can answer this question. Your disability benefits will not completely replace your income. There will be a reduction. The amount can vary depending on your plan, but you need to decide if you can live on that lower amount of income each month. Maybe you have a spouse that can help carry the load. Or a fully-funded emergency fund that will cover expenses. Or you can reduce your spending and savings for the period. If those don’t sound like viable options or you don’t have existing coverage, then you can buy private disability plans.
Private plans aren’t cheap. You’re looking at $100+ per month for someone young and healthy. It doesn’t have to be a permanent expense. Once you’ve had a chance to build-up other assets, you can cancel the plan.
Paying the Tax Man
One thing to pay attention to is whether or not your disability benefit will be taxable as that will impact how much money you get. If you pay for a private plan, then your benefit payments will not be taxed. For most employer-offered plans the payments will be taxed. My employer plan is actually non-taxable, so it’s worth checking to see how yours is handled.
Cost of Living Adjustment
Prices go up over time; that’s inflation. It’s the Bank of Canada’s job to keep inflation around 2% per year. I’m not going to go into detail about how exactly they do, just know that prices usually increase between 1% and 3% every year.
This isn’t a big deal when we’re talking about short-term disability, but it sure is if you are on long-term disability for a decade or more. What may have been a livable monthly amount ten years ago might not be in today’s dollars. That’s where a cost of living adjustment comes into play. If your disability policy has this it means that your payment will actually increase as inflation increases. It’s a good perk to have but one you will pay for with increased premiums.
Own Occupation vs. Any Occupation
Insurance companies like to make things complicated. For disability policies, the most confusing part is the own or any occupation wording. Not understanding the difference can have consequences if you need to make a claim.
If your policy says ‘own occupation’ that means it will payout if you are unable to do the exact job you currently hold. Your own job. If instead, your policy says ‘any occupation’ it won’t payout just because you can’t do the job you currently hold. If you can do a different job, then you won’t get any money.
To make things even more complicated, sometimes ‘own occupation’ policies will switch to ‘any occupation’ policies after a specific time. Again, read that fine print, so you understand precisely how you’re covered.
The more reliant you are on a steady income, the more critical disability insurance is. That means it’s usually when you are just starting out and haven’t had a chance to build up assets that you need it the most. If you’re in that situation, then find out whether you have coverage through your employer, and if not, look into a private plan. It might cost you an additional $100+ per month, but you’ll be happy to have it if you do find yourself unable to work because of an injury or illness.