Do you really need disability insurance? How to tell, and what the policy should say

If someone depends on your paycheck, the answer is probably yes

If your household could not cover its bills for an extended stretch without your income, disability insurance deserves a serious look. It is designed to replace a portion of your income if sickness or injury keeps you from working. Whether a policy actually helps you depends on its fine print: how it defines disability, how long it waits before paying, how long it pays, what it excludes and what other income it subtracts. Those terms matter as much as the decision to buy.

I am a New York Life agent in Frisco, and disability coverage is one of the two products I spend the most time explaining. My view is simple: for most working people, the ability to earn an income is one of their most valuable assets, and it is often the one with the least protection. What follows is general information to help you think it through. For questions about taxes or your specific situation, talk to a licensed professional.

A five-minute self-test

Grab your most recent pay stub, your benefits summary and a rough list of monthly bills. Then answer these honestly. If two or more answers make you uneasy, you have a gap worth closing.

• Who would feel it first if your income stopped next month: a spouse, children, aging parents, business partners?
• How many months could you cover the mortgage, debts and everyday costs from savings without selling investments at a bad time?
• Does your employer provide short-term and long-term disability coverage, and do you know the benefit formula?
• Does that formula count your commissions and bonuses, or only base pay?
• Could your spouse's income alone carry the household, and for how long?
• If you own a business, what happens to its expenses and payroll if you cannot work?

When it may not be the first priority

Disability coverage is not the right first step for everyone, and I would rather say so than sell a policy that does not fit. If you have no one depending on your income, little debt and enough savings or other income to cover your costs for a long stretch, the need may be smaller, and building savings may come first. The same can be true late in a career, when retirement assets could carry the household if work stopped early.

The picture changes quickly with a new mortgage, a child, a parent who relies on you or a business with payroll to meet. It also changes when most of your pay is variable, because the benefit formulas in many plans were written around a steady salary. If any of those describe you, the self-test above is worth taking seriously.

What coverage through work usually looks like

Many people have some disability coverage through an employer, and it is worth understanding before you buy anything else. The Maine Bureau of Insurance consumer guide, a useful plain-language reference from a state regulator, explains that short-term disability generally pays a specified percentage of pre-disability income, giving 60 percent as an example, and typically lasts no longer than six months. Group long-term disability typically begins when short-term benefits run out and may continue anywhere from five years to the rest of a person's life, depending on the plan.

Taxes change the picture too. According to the IRS, if your employer paid the premiums, the benefits are taxable to you; if you paid the entire premium with after-tax dollars, the benefits are not included in income. A benefit that looks adequate on paper can shrink once taxes are taken out. For sales professionals, the gap between base pay and total pay is often the larger issue, which I cover in my household stress test guide.

How the policy defines disability decides everything

This is the clause I read first in any disability policy. The Maine guide describes two main approaches. Under an own-occupation definition, you are considered disabled when you cannot perform the duties of your own occupation. Under an any-occupation definition, the policy pays only if you cannot perform any job you are suited for based on your training, education and experience.

Some policies combine the two. The guide gives the example of a policy that uses an own-occupation definition for two years and then switches to any-occupation, which means that after two years, being unable to do your own job no longer qualifies you for benefits. It also notes that insurers will likely look at the duties of your occupation in the national economy, not the specific duties you have with your current employer. For a sales director whose income depends on travel, presentations and long days, the difference between these definitions can be the difference between a paid claim and a denied one.

• Own occupation: pays if you cannot do the material duties of your occupation.
• Any occupation: pays only if you cannot do any job reasonably suited to your background.
• Split definitions: own occupation for a set period, then any occupation.
• Income-loss language: some policies pay when sickness or injury keeps you from earning a certain percentage of your prior income.

Waiting periods and benefit periods

The elimination period is the number of days from the start of a disability until benefits become payable. The Maine guide notes that no benefits are paid during this time and that you are generally still responsible for premiums. Choosing a longer elimination period usually lowers the cost, because the insurer starts paying later, but it means your savings must carry you through the gap. I usually start this conversation by asking how many months of expenses a client keeps in cash.

The benefit period is how long payments can continue once they start, which might be a set number of years or to a stated age. The guide specifically recommends checking a policy's maximum benefit period, and notes that many long-term claims come from common medical conditions that worsen over time, not only from dramatic accidents. A short benefit period can leave a household exposed exactly when a disability turns out to be long.

Limitations and exclusions to read before you sign

Every disability policy has limits, and you want to know them while you are healthy, not when you file a claim. The Maine guide points out that a common limitation caps benefits at 24 months for disabilities arising from mental or nervous disorders, and that some policies limit benefits for conditions based on self-reported symptoms not supported by medical testing.

Pre-existing conditions are handled through look-back and look-forward periods. The guide describes a typical look-back of six months to a year and a look-forward of about one year: if you were treated for a condition shortly before the policy started and become disabled from it during the first policy year, the claim may be denied. Individually underwritten policies can also carry exclusions tailored to your medical history, and unlike a pre-existing condition limit, an excluded condition will never be covered under that policy.

If you are looking at a policy now and are not sure what its limitations mean for you, this is a good moment to have someone go through it line by line with you.

Offsets, taxes and the size of the actual check

A benefit amount on the application is not always the amount that arrives. Many policies reduce benefits by other income you receive, a feature called an offset or integration. The Maine guide lists workers' compensation, Social Security benefits, other insurance and retirement plan benefits among the sources that may reduce what a disability policy pays. It also warns that if an insurer pays the full amount while another benefit is pending, you may have to repay an overpayment later.

Add the tax rules from the IRS, and the real question becomes: after offsets and taxes, how much would land in your account each month, and is that enough? That is the number I build every recommendation around. For tax specifics, coordinate with your CPA, since New York Life and its agents do not provide tax advice.

Features worth asking about

Riders and policy features add cost, so each one should solve a real problem. The Maine guide suggests asking whether riders such as cost-of-living adjustments are available, and whether a policy requires total disability or will pay for partial disability. These are the questions I make sure clients can answer about any policy they consider.

• Does the policy cover both accidents and illness?
• Will it pay a partial benefit if I can work, but earn less, after an illness or injury?
• Is there a cost-of-living adjustment once benefits start?
• Can I increase coverage later as my income grows without new medical underwriting?
• Are premiums waived while I am receiving benefits?
• How long is the free-look period if I change my mind?

Talking it through with real scenarios

I prefer to discuss disability coverage using real-life scenarios rather than pressure: a back injury that keeps you off planes for a year, a cancer treatment that takes eight months, a slow-developing condition that ends a career early. We look at what your employer plan would pay in each case, after taxes and offsets, and what would be left uncovered. Then we look at coverage options and solutions for different goals and budgets. The application itself works much like the process I describe in my guide to life insurance underwriting, with health questions and a review of your income documentation.

I meet with clients in Frisco and across the northern Dallas suburbs, in person, by phone or by video, and there is no obligation to buy. Once coverage is in place, it should be revisited as your income changes; my yearly review checklist shows what to look at and when.

Questions people ask me