How Does Disability Insurance Work?

Disability insurance replaces part of your paycheck, usually around 60%, if an illness or injury keeps you from working. Two things decide whether it helps you: how long you’ll wait for the first payment, and how your policy defines disabled. That definition varies among policies.

The risk isn’t remote. About 1 in 4 of today’s 20-year-olds will become disabled and qualify for Social Security disability benefits before age 67, according to the Social Security Administration.

What is disability insurance?

Disability insurance replaces part of your income if you can’t work after a qualifying illness or injury. It can provide a financial bridge until you can get back to work. And if you’re unable to return to your job, you might receive payments for years, depending on the policy. You can use the benefits you receive to pay your mortgage, utilities, phone bill or anything else you might need.

How disability insurance works

Insurance premium

The amount you have to pay to buy a policy. Policies with higher coverage amounts and longer benefit periods generally cost more.

Definition of a disability

Getting sick or injured doesn’t automatically qualify you for disability payments. You have to meet the insurer’s definition of disability, and what “counts” varies by policy.

An "own occupation" policy pays if you can’t do your current job. An "any occupation" policy pays only if you can’t do any job you’re reasonably qualified for.

‍The two terms that decide everything
• Waiting period — how long you're disabled before payments start, often 90 days or more. You're covering your own bills until then, so it tells you how much savings you need.
Definition of disability — whether the policy pays when you can't do your job (own occupation) or only when you can't do any job you're suited for (any occupation). A surgeon who can't operate but could teach gets paid under one and denied under the other.

Claims process

You must submit a claim to receive a payout from the insurer. File your claim as soon as you know you’ll meet the insurer’s waiting period. You might need to include statements from your doctor and employer with your claim. The statements help your insurer understand how your injury or illness impacts your ability to work.

If your claim is denied, you can appeal. Employer plans must give you at least 180 days to request a review, and the Department of Labor’s Employee Benefits Security Administration can explain your rights at 866-444-3272. For an individual policy, submit a complaint directly to your state insurance department.

Waiting period

Sometimes called an elimination period, this is the amount of time you’ll wait to receive payments after a disability begins. During the waiting period, you’ll need another way to cover bills. Paid sick leave or PTO, a short-term disability policy, or a state program can bridge the gap. California, Hawaii, New Jersey, New York, Rhode Island, and Puerto Rico all run mandatory short-term disability programs.

Benefit payments

When the waiting period is up, you receive benefit payments if your claim is approved. Payment amounts vary based on the terms of your policy. Some plans provide a reduced benefit if you can only do part of your job and earn less than you did previously.

Benefit period

The length of time you receive payments. Benefitperiods can range from a few months to several years. Some plans even pay until retirement age, if you qualify. Choosing a shorter benefit period can save you money on your premium, but your payments may end when you still need them. A longer period provides more coverage, but it usually costs more.

Short-term vs. long-term disability insurance

You can choose from two types of disability insurance policies:

• Short-term coverage. Usually starts paying after a week or two and lasts three to six months. It can cover you until you’re back at work or long-term coverage begins.
• Long-term coverage. Usually starts paying about six months after your disability begins. Payments can last years if a serious illness or injury keeps you from working.

Where to get disability insurance

You can get disability insurance from a few places, including:

• Your employer. This is usually the best place to start, if your job offers a plan. Your employer might offer short-term disability insurance, long-term disability insurance, or both.
• Individual insurers. An individual policy can supplement an employer-sponsored plan or provide benefits if your employer doesn’t offer disability insurance. But you have to pay the full premium.
• Social Security Administration (SSA). Social Security Disability Insurance (SSDI) pays only if your condition is expected to last at least a year or result in death, and you must have enough work history to qualify. It doesn’t pay short-term or partial disability benefits. Payments start after a five-month waiting period and are based on your lifetime earnings, not a percentage of your income.
• Your state. Five states and Puerto Rico run mandatory short-term disability programs, usually funded through payroll deductions.

‍Don’t count on workplace coverage. At private employers with fewer than 50 workers, only 30% of workers have access to short-term disability and 21% to long-term, according to BLS. And group coverage usually doesn’t follow you to a new job. Instead, you’d reapply later, at whatever age and health you are then.

How much does disability insurance pay?

A typical policy replaces about 60% of your income.

On a $4,000 monthly income, a policy paying 60% sends you $2,400 a month. If that benefit is taxable, what you keep is less, depending on your tax bracket. A tax-free $2,200 benefit can leave you with more than a taxable $2,400.

Whether your benefits are taxed depends on who paid the premiums. If your employer paid them, or you paid through pre-tax payroll deduction, your benefits are taxable. If you paid the premium with after-tax dollars, including on an individual policy, they aren’t. If you and your employer split the premium, only the employer’s share of the benefit is taxed.

When evaluating plan options, compare the amount of the payout you’d get to keep with the expenses you need it to cover. Your benefit may be reduced if you also get SSDI or other disability income, depending on your policy.

Talk with a tax professional to understand the tax implications of receiving disability benefits. The IRS's free VITA program helps people with disabilities, and people who generally earn $69,000 or less, with their taxes.

What disability insurance does and doesn’t cover

Disability insurance covers qualifying illnesses and injuries, and what qualifies varies by policy. Some plans cover disabilities from accidents only, not illness, so check before you buy. A policy might also pay a partial benefit if you can still work but earn less because of your disability.

Every policy lists situations it won’t pay for, so read that list before you buy. You also won’t get benefits if you recover before the waiting period ends.

Bottom line

Disability insurance won’t replace your wholepaycheck, but the right policy, with a waiting period you can bridge and a definition of disability that fits your job, can keep your bills paid while you recover.

Your policy won’t show up on your credit report. Your payment history will, and it’s what lenders look at when you need to borrow later. The Kikoff Credit Account reports your on-time payments to Equifax, Experian and TransUnion, with no credit check to sign up. Plans start at $5 a month.