Disability insurance, short term, long term, and own occupation

How it works

A short term policy, often provided by an employer, pays a percent of salary for a limited period, commonly three to six months, after a brief waiting period. A long term policy begins after a longer elimination period, often 90 days, and pays a percent of pay, commonly 60 percent, up to a monthly cap, for a set number of years or to a set age. The definition of disability matters: an own occupation policy pays when the insured cannot do their own job, while an any occupation policy pays only when they cannot do any job suited to their training. Taxation follows who paid the premium. Benefits from a policy the employer paid for with pretax dollars are taxable income, while benefits from a policy the worker paid for with after tax dollars are tax free.

What it gives

It replaces the income that every other financial plan depends on.

Benefits from a policy paid with after tax dollars arrive tax free.

An own occupation definition pays even when some other kind of work is possible.

What it costs, or where the catch is

Employer paid benefits are taxable, so 60 percent of pay becomes less after tax.

Long term policies are costly for a worker in a physical trade and exclude pre existing conditions for a time.

The elimination period means months with no benefit, which has to be covered from savings.

A worked example

Soraya earns $6,000 a month and her employer's long term policy pays 60 percent, which is $3,600 a month, after a 90 day wait. The employer pays the premium, so the $3,600 is taxable, leaving her about $3,100 after tax. She adds an own occupation policy of her own for $1,500 a month at a cost of $55 a month, paid with after tax dollars, so that $1,500 would arrive tax free. Her total during a long disability would be about $4,600 a month after tax.

Where it goes wrong

The common miss is reading a policy's 60 percent and planning on that figure, without noticing the employer paid the premium and the benefit will be taxed.

Who confirms it for you

For your own numbers, an insurance agent. This page explains how the rule works for people in general; it does not know your situation and does not tell you what to do.

The official source

IRS Publication 525, Taxable and Nontaxable Income. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.