I’ll be doing a series of posts over the next few weeks on disability insurance. The subject is sufficiently broad, and sufficiently important, that one post isn’t going to cut it. This post will be the first in the series, and a bit of an introduction into the subject of disability insurance.
Disability Insurance is More Complicated Than Life Insurance
If you read the recent post on life insurance, you know that buying life insurance isn’t particularly complicated, and won’t require more than an hour or two of your time. Unfortunately, disability insurance is FAR more complicated, and while it may not require a ton of time to understand and purchase a policy, it will require more self-education and a lot more decisions to be made.
Similarities to Life Insurance
Both life insurance and disability insurance are INSURANCE products. That means they must be bought from an agent. You are better off buying both types of policies from an independent agent that can sell you policies from multiple companies rather than a “captive” agent. The same policy will cost the same no matter which agent you buy it from. Agents, of course, may be compensated more for selling you one policy than another, but they are unlikely to disclose that to you, and the differences aren’t great for similarly priced policies. You hope that you’ll never collect on either one of them.
Both life and disability insurance are also designed only to address the financial aspects of a tragedy. Just like life insurance doesn’t bring a loved one back, disability insurance doesn’t fix your disability. Both simply protect income. If you die and cannot produce the income your family needs, life insurance will provide it. If you become disabled and cannot produce the income you and your family needs, disability insurance will provide it. Both policies, of course, can be dropped as soon as the physician becomes financially independent from his investments. There shouldn’t be an emotional factor to buying these policies– it’s simply business.
Differences Between Life and Disability Insurance
Disability is subjective. You know very well as a doctor that disability is subjective. With life insurance, someone is either dead or alive. Not infrequently, I find myself saying those simple words, “Time of death….9:21.” There really isn’t a “time of disability.” Unfortunately, this aspect makes insuring against it far more complicated. You cannot buy disability insurance like a commodity. For the most part, all 30 year level-premium term life insurance policies are the same. You just buy the cheapest one. No two disability insurance policies are the same. The definition of disability becomes all important.
Disability is complicated. You must read the entire policy and discover when it will pay out and when it won’t. For example, many policies don’t pay out until you’ve been disabled for 60, 90, or even 180 days. Guess which one costs more? Some policies will only pay for two years if you are disabled with a psychiatric illness, while others will pay out until you’re 65. Guess which one costs more? Some will increase the payout with inflation each year. Guess who pays for that? There are dozens of differences between policies and options within each policy.
Disability is taxed differently. Life insurance payouts are always tax-free to the beneficiary. Not true with disability insurance. It turns out the benefits are tax-free if you paid the premiums with post-tax dollars, but fully taxable if you paid with pre-tax dollars, such as through an employer’s group plan. Disability insurance is also more expensive than life insurance. This is mostly because it has a higher likelihood of being used. But consider a physician who makes $200,000 a year. A typical rule of thumb is to get 10 times your salary in term life insurance. A 30 year level-premium term life insurance policy might cost $1600 a year, or about 0.8% of your income. A disability insurance policy that will pay $10,000 a month (only 60% of salary) in the event of disability is likely to cost $3000-6000/year, or about 2% of his income (but 3-5% of the income actually covered by the policy).
Disability insurance is sold in proportion to your income. Disability insurance generally gets more expensive as you get older because the likelihood of using it gets higher. Residency can be a great time to buy it because you get lower rates (not only for age, but also sometimes because a resident is put into a different classification of physician than an attending). But as a resident, you cannot buy enough of it (or afford enough of it) to cover the rest of your career. A brand new attending can buy more of it, and isn’t much older, so this isn’t a bad time to buy either. A resident and new attending also have a great need for life insurance, since they have few assets and lots of liabilities.
Physician income levels can increase dramatically the first few years out of residency, due to making partner or building a successful practice, so it isn’t uncommon for a doctor to need to replace a policy, or purchase an additional one at that time also. As the years go by, the disability insurance policies offered by the companies add new features, which may be particularly desirable to you. Although they’ll cost you more due to the additional features and your increased age, it might be worth it to you to get those features, so updating policies even mid to late career can make sense too.
Disability insurance is more likely to be used than life insurance. Studies have shown that 10-20% of people will have a period of disability of some kind between the ages of 25 and 65. Those odds are simply too high not to insure against that type of financial catastrophe. If you do not currently have disability insurance, it is time to get serious about it and cover that risk.