Insurance That Will Protect Your Income

EDITOR'S NOTE: This article was originally published in the April 2011 issue of Kiplinger's Retirement Report. To subscribe, click here.

Multiple sclerosis ended Charles Silberman's career as a periodontist. Only 55, Silberman no longer works. Still, he's getting a monthly check that comes close to matching his old income. The reason: a disability insurance policy.

Silberman bought the coverage when he was in good health. He didn't want to take the chance that his wife and four children would face what he did as a teen, when his father became disabled and was unable to work. The policy kicked in after he cut back his hours and his income dropped by 20%. Today, the policy replaces most of his income. "We have been able to maintain our house, lifestyle and standard of living," he says.

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You likely have homeowners insurance, and you may have life insurance. But if you're still working, have you protected your income? Disability insurance replaces a portion of your income if an illness or an accident prevents you from working.

You can buy a full policy if you're self-employed or a supplemental plan if your employer coverage is skimpy. The policies pay monthly benefits if you can't work at all, and some pay partial benefits if you can work only part-time. "Disability insurance is not about you, it's about your family not having to deal with consequences" of a breadwinner's disability, says Connie Golleher, chief operating officer of the Holleman Companies, an insurance advisory firm in Chevy Chase, Md.

Protecting income is particularly important if you're 50 and older, when you are probably in the homestretch of building up retirement savings. This also is the age when health problems are likely to accelerate, says Michael Fradkin, a senior vice-president at MetLife who manages disability insurance products. The most common disability claims MetLife receives from this age group are for cancer, arthritis and joint inflammation, and back strain.

Most states require employers to provide disability coverage for a few weeks or months. Many employers don't offer coverage beyond that. Even companies that offer long-term coverage tend to cover just 50% of income, says Golleher. Some firms offer the option to buy extra coverage at group rates and without underwriting, so you don't have to pass a medical exam.

Buying through a group, including a professional association or AARP, can save money, says William Franklin, a certified financial planner whose Hunt Valley, Md., firm helps clients buy disability and other insurance products. Group plans are a better deal for women because individual policies cost them 35% to 40% more than men pay for the same coverage. The rates on group coverage typically are the same for men and women.

If you can't get group coverage, you need to go to the individual market. It's best to find a trusted broker to guide you. "You have multiple companies calling the same feature by different names," says Franklin.

Generally, the older you are when you buy coverage, the higher the premium. A policy that pays a $5,000 monthly benefit through age 66 for a 55-year-old healthy male might cost $3,840 a year; the same policy costs $2,228 for a healthy 50-year-old man. For healthy women, a policy that costs $5,429 for a 55-year-old woman might cost $3,389 for a 50-year-old.

The premium drops a bit for a 60-year-old because the benefit period of six years is so short. It's $2,726 for a man and $3,385 for a woman.

Coverage, availability and price depend on your health, your age, whether you smoke and other factors. Pricing also depends on your occupation and the level of income you want to replace. Expect to take a basic medical exam. Insurers may exclude any preexisting conditions, add a surcharge to cover those with health problems or deny coverage.

Policies typically cover up to 50% to 70% of gross income. Tote up your expenses and other sources of income to calculate the amount of insurance you need. Also, figure the length of time you want to receive a monthly benefit. Here are other things to consider:

Definition of disability. Insurers define disability in different ways. Some pay if you cannot perform the duties of your "own occupation." Others only pay if you are unable to perform the duties of "any occupation." A bit more expensive, "own occupation" policies are preferred because they offer broader protection.

Benefit period. Benefit periods are the amount of time you elect to receive monthly benefits. Common benefit periods run from five years, to age 65, to age 67 or a lifetime. A longer benefit period will increase your monthly premium. Match the benefit period to your expected retirement age.

Residual coverage. This feature allows you to work part-time or at another lower-paying job and still collect a benefit to make up for lost income. While standard in some policies, a residual benefit can be added as a rider in others. Another perk: This feature pays partial benefits based on income loss even if you don't have an initial period of total disability.

A "non-cancelable" policy. You want coverage that an insurer can't cancel and will renew every year at the same price. If you instead go with a policy that is just "guaranteed renewable," the coverage is less expensive upfront, but the premiums could rise.

Elimination period. This is the waiting period, or the number of days you have to be disabled, before benefits begin. You usually get the best rate at 90 days. Reducing the period to 60 days can lead to a 50% surcharge.

You can add other riders. One is a cost-of-living adjustment, although inflation protection may not be necessary if you're in your fifties or your spouse works. Another is a future purchase option, which allows you to buy added coverage as your income increases without having to go through underwriting again. With his policy, Silberman included both kinds of riders and even one that pays the premiums of his life insurance policy.

Other riders or policies can help you maintain your retirement-plan contributions, provide a long-term-care benefit or convert to a long-term-care policy. Avoid policies that cover income if you are disabled by a specific condition such as cancer -- you're better off with an overall disability policy. Consumers should also know what triggers a policy or a particular rider.

Also, while benefits paid under an employer-provided policy are taxed, benefits from an individual policy are generally tax-free, as long as you pay the premiums with after-tax dollars.

Make sure the insurer you choose gets top ratings from A.M. Best Co. (www.ambest.com), Moody's Investors Service (www.moodys.com) or Standard & Poor's (www.standardandpoors.com).