How Social Security Disability Insurance Works

If you and your family count on your paycheck, you're counting on yourself to stay healthy. However, that isn't guaranteed. The Social Security Administration estimates that before retirement, one out of every four 20-year-olds will end up with a disability that keeps them out of work for at least a year.¹

While Social Security Disability Insurance offers some protection in case you can't work, there are limits to when — and how much — this program will pay. That's why it could be a good idea to buy your own policy for disability insurance benefits.

Curious to learn how disability insurance works? Here's what to know about these policies and how to decide if you could use one.

What Is Disability Insurance?

Disability insurance pays you each month if you become disabled. It's usually a percentage of your pre-tax income. For example, if you make $4,000 a month before taxes and your policy covers 60% of your income, you would get $2,400 a month after a disability.

When you sign up, you'll be asked to decide how much you want for the disability insurance payment. The larger the benefit, the more the policy costs.

If you end up partially disabled, the disability insurance could make a partial payment. For instance, if your disability means you can only work half a week, you receive half your benefit.

When Do Payments Begin?

There are two main categories of disability income insurance: short-term and long-term. They differ in how quickly they start payments and how long they make payments. Disability insurance policies typically have a waiting period before payments begin that's known as the elimination period. For example, if you have a one-month elimination period, you must be disabled for longer than a month to receive anything.

Short-term disability insurance policies have shorter waiting periods. It's usually under two weeks. While the payments start sooner, they end quickly as well. Short-term disability policies typically limit payments to a few months, depending on your contract terms. Two years is the longest they will pay.

Long-term disability insurance policies take more time to start making payments. It usually takes several months, with 90 days being the most common elimination period. In exchange, these policies make payments for a longer amount of time.

Benefits can last multiple years. You can set up a long-term disability insurance policy that makes payments until you turn 65, retirement age or even for the rest of your life. The longer the disability insurance benefits payout period, the more your policy is likely to cost.

Which Physical/Health Issues Qualify for Payments?

Insurance companies typically have a broad view of what qualifies for disability insurance benefits. Rather than providing a list of specific illnesses and injuries, they look at whether your disability is serious enough to keep you from working. A medical provider must make this determination.

Some issues that could qualify include:

• Heart problems
• Cancer
• A back injury
• Blindness
• A lost hand or finger
• Pregnancy

Insurance policies have different standards for what counts as a disability. Some use a loose "own occupation" standard. You qualify when a disability keeps you from doing your own job. Others use a strict "any occupation" standard. This means the disability must be so severe it keeps you from doing any work at all.

If a surgeon were to lose a hand, they would probably qualify for disability under "own occupation" because they can no longer perform surgery. However, they might not qualify under "any occupation" because they could still potentially give medical advice, teach students, etc.

How Does Private Insurance Compare to Government Programs?

The federal government provides disability insurance benefits through Social Security. It runs two programs: Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI). Both programs support people with a serious disability that will keep them out of work for at least a year.

Anyone working and who has paid enough in Social Security taxes can qualify for SSDI. SSI is only available for those with very limited financial resources.² You can only apply if you have less than $2,000 in assets.

The key difference between SSDI and private insurance is how hard it is to qualify for benefits. SSDI uses the strict "any occupation" definition whereas private insurance could use "own occupation." SSDI also takes months to make a decision and start payments. Private insurance could begin sooner.

SSDI only covers total disability where you can't work at all. Private insurance could make partial payments for a partial disability. Lastly, there is a limit to how much SSDI will pay per month. It could be less than what you need to cover your current bills. Extra private insurance can make up the difference.

What Are the Benefits of Disability Insurance?

There are a number of potential advantages to disability insurance. Someone who qualifies might decide to sign up for the following reasons:

Keeps your income going

Medical issues are a leading cause of bankruptcy in the United States. Not only do people struggle to cover the cost of care, but they also end up missing work. When someone stops earning money, they might fall into debt, miss payments on their rent or mortgage and risk eviction or foreclosure, or have other serious financial trouble. Disability insurance keeps income coming in. That way, they can just focus on their recovery.

Protects your savings

For them, a serious disability would drain this money quickly. It may even force people to withdraw from their retirement plans. This can lead to extra taxes and IRS penalties while also setting back retirement goals.

With disability insurance, you can get replacement income and might not need to spend down your emergency fund or your retirement plans.

Offers tax-free benefits

If you pay for your own disability insurance, you usually receive the benefits without having to pay income tax. That's why people usually set up benefits as a percentage of their salary (40% to 70%). Since taxes won't be coming out, the payments don't need to replace 100% of your pre-tax income.

Fills the gaps in government programs

As noted, Social Security can also provide long-term disability insurance payments. However, it takes time to qualify. Private disability insurance can help cover the bills until you qualify for government support. It also can give you extra coverage, like more money per month or payments for a partial disability.

What Are the Possible Drawbacks?

There are some downsides to disability insurance. Someone who qualifies might decide not to sign up for reasons such as these:

Cost of coverage

The insurance nonprofit Life Happens gives a general guideline that a long-term disability insurance policy typically costs about 1% to 3% of your pre-tax income per year.⁴ Disability insurance is often more expensive for older applicants and those with health issues that increase the chance of a disability. It also costs more for applicants working in more dangerous occupations, like construction.

Use-it-or-lose-it benefits

Like most types of insurance, most disability policies follow a use-it-or-lose-it setup. In other words, you only get money back if you become disabled.

Wait time before payments

Most disability insurance policies have an elimination period. This means you might need to wait days, weeks or months before getting any money. If you recover from your injury or illness before the end of the elimination period, you likely won't receive any payments.

Coverage qualification

To qualify for disability insurance, you usually need to undergo (and pass) medical underwriting. If you have health issues or other preexisting conditions, the insurer could potentially charge you more.

Are There Alternatives to Disability Insurance?

Worker's compensation provides disability benefits if you get hurt or sick at work. However, it will not cover disability caused outside of your workplace.

Your employer might also offer group disability as an employee benefit. They may pay some or all of the insurance premiums. That way, it's less expensive than buying your own policy. However, if you leave the job, you typically lose your disability coverage.

Another option is to buy a critical illness insurance policy. These policies provide a list of issues they would cover, like heart attack, stroke, cancer, paralysis or an organ transplant. If one of these happens to you, the policy pays you a single, lump-sum benefit. You only receive one payment versus ongoing payments from disability insurance.

Last, if you have a life insurance policy, you can set up a disability waiver of premium rider as an extra benefit. If you become disabled, the insurer stops charging you the life insurance premium. This can allow you to have one less bill and not worry about losing your protection. If your policy has cash value, it will also continue to grow for the future.

Do You Need Disability Insurance?

Consider how you'd manage a long stretch without income because of a disability. Insurance can be an effective way to do so, but it's not the only way. If you have considerable savings or protection from an alternative, you may not need your own individual policy.

It's also possible that your current financial plan helps protects against some types of disability but not all. You could use insurance to fill the gaps.

For example, you may skip short-term disability insurance because you have enough in savings to replace your income for a few months. However, you can set up a long-term disability policy to help protect against a lasting issue. Alternatively, you might use short-term insurance for quicker illnesses or injuries with the plan that if you have a serious problem, you'll qualify for SSDI.

Another financial consideration is whether you can afford the premiums. If you're worried about the cost, you could set up a less expensive policy that only fills some of the income loss from not working. You can do this by reducing the size of the monthly benefit, shortening the maximum payout period, and increasing the elimination waiting period.

In this scenario, your premiums could be more affordable while you still have some protection. If you became disabled, you would at least have some replacement income, so everything wouldn't have to come out of your savings.

How Do You Apply for Disability Insurance?

There are various ways to apply for a disability insurance policy. Here's a four-step approach:

Contact an insurance company selling disability policies

Upon contacting the disability insurance company, you will be put in touch with a financial professional. They will review your financial situation and explain their policies. You can then decide what type of disability insurance to buy (short- or long-term), the amount of coverage, the elimination period and any other benefits you might want to add to the policy.

Submit an application

If you're interested in disability insurance, you'll need to submit an application. This will list what type of policy you'd like to buy, your contact information, your occupation and your current earnings. Because disability insurance is based on replacing your current earnings, you may need to submit pay stubs or your tax return to show how much you're currently making. You might also need to answer health questions and take a medical exam.

Receive the insurer’s decision

The insurance company will review your application, earnings and medical records. After review, they will decide whether you qualify and at what premium. If you have preexisting medical conditions, they could charge more, deny the application or give you a policy that excludes covering the condition. For example, if you have an existing heart problem, the policy might not cover disability from future heart issues but would for any other cause.

Accept the policy offer and pay your premium

If you are happy with the insurance offer, you can pay the first premium to set up coverage. From there, you'll be covered as long as you keep up with the premium payments. Should you ever end up being disabled, you will contact the insurance company, file a claim and get a doctor to verify that you are disabled. Once you get past the policy elimination period, you'll start receiving your disability insurance benefits.

Bottom Line

Your need and eligibility for disability insurance depends on many factors. If you feel you could benefit from more information or a personalized look at your individual situation, consider meeting with a financial professional. With their help, you can decide if you need disability insurance and, if so, get the application process started.

Sources

1. Mahel J, Bosley T. Disability and death probability tables for insured workers born in 2000. Social Security Administration. https://www.ssa.gov/oact/NOTES/ran6/an2020-6.pdf.
2. Understanding Supplemental Security Income (SSI) eligibility requirements — 2022 edition. Social Security Administration. https://www.ssa.gov/ssi/text-eligibility-ussi.htm
3. Velasquez F. Over half of Americans have less than 3 months worth of emergency savings. CNBC. https://www.cnbc.com/2021/07/28/51percent-of-americans-have-less-than-3-months-worth-of-emergency-savings.html.
4. How much does disability insurance cost? Life Happens. https://lifehappens.org/disability-insurance-101/how-much-does-disability-insurance-cost/.