Key Takeaways
- Disability income insurance protects earned income when illness or injury prevents work.
- Replacement benefits typically target 60-70% of pre-disability income.
- Coverage can be short-term or long-term based on elimination and benefit periods.
- Sources include employer group plans, individual policies, Social Security, and workers' comp.
- Group coverage is often taxable if employer-paid; individual coverage is typically tax-free.
- Disability risk is statistically higher than premature death during working years.
Last updated: December 2025
Purpose of Disability Insurance
Disability income insurance provides financial protection when illness or injury prevents someone from working. It's often called "paycheck protection" because it replaces lost income during a disability.
The Importance of Disability Coverage
The Income Protection Gap
| Risk | Protection Available |
|---|---|
| Death | Life insurance |
| Medical expenses | Health insurance |
| Property loss | Property insurance |
| Lost income due to disability | Often uninsured |
Disability Statistics
| Statistic | Reality |
|---|---|
| Likelihood of disability | 1 in 4 workers will become disabled before retirement |
| Average disability duration | 2.5 years |
| Leading causes | Musculoskeletal, cancer, mental health, cardiovascular |
| Financial impact | 48% of foreclosures linked to disability |
Key Point: Disability is more likely than death during working years, yet fewer people have disability coverage than life insurance.
Income Replacement Philosophy
Purpose of Disability Income Insurance
| Goal | Description |
|---|---|
| Replace lost income | Provide ongoing payments when unable to work |
| Maintain standard of living | Cover regular expenses |
| Prevent financial hardship | Avoid debt, bankruptcy, foreclosure |
| Bridge to recovery | Support until return to work or retirement |
What Disability Insurance Does NOT Cover
| Not Covered | Reason |
|---|---|
| Medical expenses | Covered by health insurance |
| Full salary | Benefits capped to prevent over-insurance |
| Investment losses | Not income protection |
| Business losses | Requires business overhead expense insurance |
Sources of Disability Income
Private Sources
| Source | Description |
|---|---|
| Individual disability insurance | Personal policies purchased from insurers |
| Group disability (employer) | Short-term and/or long-term disability |
| Business overhead expense | Covers business expenses during disability |
| Key person disability | Protects business from loss of key employee |
Government Sources
| Program | Eligibility |
|---|---|
| Social Security Disability (SSDI) | Work credits, strict definition of disability |
| Workers' Compensation | Work-related injuries/illnesses only |
| State disability programs | 5 states + Puerto Rico |
| Veterans benefits | Service-connected disabilities |
Social Security Disability Insurance (SSDI)
| Feature | Details |
|---|---|
| Definition of disability | Unable to engage in any substantial gainful activity |
| Duration requirement | Expected to last 12+ months or result in death |
| Waiting period | 5-month elimination period |
| Benefit amount | Based on lifetime earnings |
| Approval rate | Only ~35-40% of applicants approved initially |
Exam Tip: Social Security uses a strict "any occupation" definition—you must be unable to do ANY work, not just your own occupation.
Short-Term vs. Long-Term Disability
Short-Term Disability (STD)
| Feature | Typical Details |
|---|---|
| Elimination period | 0-14 days |
| Benefit period | 13-26 weeks |
| Benefit amount | 60-70% of salary |
| Common source | Employer group plans |
| Replaces | Sick leave coverage |
Long-Term Disability (LTD)
| Feature | Typical Details |
|---|---|
| Elimination period | 90-180 days |
| Benefit period | 2 years to age 65 (or longer) |
| Benefit amount | 50-70% of salary |
| Common source | Employer group or individual |
| Coordinates with | STD, Social Security, Workers' Comp |
How STD and LTD Work Together
Timeline:
Day 1-90: Short-term disability benefits
Day 91+: Long-term disability benefits begin
Individual vs. Group Disability
| Factor | Individual | Group |
|---|---|---|
| Underwriting | Individual health review | Guaranteed or simplified |
| Portability | Stays with insured | Usually ends with employment |
| Cost | Higher premiums | Lower (group rates) |
| Customization | Highly customizable | Standard plan design |
| Ownership | Insured owns policy | Employer owns policy |
| Taxation | Benefits tax-free if premiums paid with after-tax dollars | See taxation rules |
Taxation of Disability Benefits
| Who Pays Premium | Tax Treatment of Benefits |
|---|---|
| Employee (after-tax) | Benefits received tax-free |
| Employer | Benefits are taxable income |
| Shared | Proportionally taxable |
Example
- Employer pays 60% of premium → 60% of benefits taxable
- Employee pays 40% of premium (after-tax) → 40% of benefits tax-free
Key Point: Many financial advisors recommend employees pay disability premiums with after-tax dollars to receive tax-free benefits when disabled.
Key Takeaways
- Disability income insurance protects earned income when illness or injury prevents work.
- Replacement benefits typically target 60-70% of pre-disability income.
- Coverage can be short-term or long-term based on elimination and benefit periods.
- Sources include employer group plans, individual policies, Social Security, and workers' comp.
- Group coverage is often taxable if employer-paid; individual coverage is typically tax-free.
- Disability risk is statistically higher than premature death during working years.
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Test Your Knowledge
What is the primary purpose of disability income insurance?
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Test Your Knowledge
If an employer pays 100% of the disability insurance premium, how are the benefits taxed when the employee receives them?
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D
Test Your Knowledge
What is the typical benefit period for long-term disability insurance?
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D