Key Points:

• For younger individuals or families, or those who don’t have enough savings and assets to be considered “self-insured”, life and disability insurance can be an integral part of their financial plan.

• Life and disability insurance provide much needed financial protection to a family in the event of death or disability of the primary or sole income earner.

• When considering all the different types of insurance options available today, it is important to focus on how much money or income you think you and your family will need over a certain period.

According to the Social Security Administration, a person who turned twenty years old in 2017 has a 6.1% chance of dying before normal retirement age and a 26.8% chance of becoming disabled.¹ As sobering as these statistics are, they are very much a reality of life.

Life and Disability Insurance: Essential Protection Against the Loss of Income

As with most financial decisions, the need for life insurance and disability insurance depends on an individual’s situation.  For some people, life and disability insurance may not be needed because they are older and have enough savings and assets to “self-insure” themselves and their families. For most other people however, not having life and disability insurance as part of their financial plan can be risky.

Without life insurance, the death of the primary or sole income earner of a young family—with children and little savings—could result in the family not having the means to pay for regular living expenses, let alone the children’s educations down the road. Similarly, without disability insurance, if the primary or sole income earner was unable to work and required ongoing medical assistance, the family would be in a tough financial situation; they would have both a loss of income and substantial medical costs. Life and disability insurance would have provided much needed protection in these situations.

How Life Insurance Works

Life insurance is a contractual agreement between you and an insurance company, where they agree to pay you a lump sum of money (benefit) upon your death in exchange for ongoing premium payments up until that point. There are many different forms of life insurance; the two most common are “term” and “whole” life insurance.

Term life insurance is often referred to as “pure insurance” since it only pays out benefits in the event of death. One of the key benefits of term life is that it is less expensive than whole life. The limitations with term life insurance policies are that they expire after a set period (e.g., five years, ten years, etc.) and that they get more expensive (i.e., higher premiums) if you establish a new policy at an older age.

Whole life insurance combines the pure insurance aspect of term life with a “cash value” savings or investment component. A portion of the ongoing premium payments is allocated towards the regular cost of the insurance and the remaining portion is saved and invested in a cash value account. Unlike term life, whole life is deemed a “permanent” policy with no set expiration date, provided that you continue to make premium payments.

How Disability Insurance Works

Disability insurance is a contractual agreement between you and an insurance company, where they agree to pay you a set percentage of your earned income if you become disabled in exchange for ongoing premium payments up until that point. Typically, only 60-70% of your earned income will be covered by the disability policy; this may depend on your profession. Additionally, there are both “short-term” and “long-term” disability policies. Short-term disability policies typically provide coverage for a limited period (usually less than two years) and may have a cap on total benefits received.  Long-term disability coverage typically begins once the short-term coverage ends and can typically last until age sixty five.

The Benefits of Having Life and Disability Insurance

There are numerous benefits to having life and disability insurance, including:

• Peace of mind

• Can provide funds to cover basic living expenses in the event of death or disability

• Gives a family time to become self-sufficient

• Can provide funds to cover funeral expenses

• Can act as an additional savings or investment tool

• Life insurance proceeds are generally not taxable to the beneficiary

• Disability payments from private insurers will usually not affect Social Security benefits

How to Get Coverage

One place that most people get life insurance coverage is through their employer. Many employers offer a base “group” term life policy, which is typically less expensive than an “individual” term life policy that you would get on your own. Typically, employers pay for the entire cost of this base coverage. The other major benefit of this type of coverage is that “underwriting” is not typically required, so you don’t have to go through a health assessment or medical testing. However, if you think the death benefit of your employer’s group term life policy is not enough coverage for your family, you can get additional coverage through an individual life policy by going directly to an insurance company (or an insurance agent). Approval for an individual life policy will require underwriting.

Similar to life insurance, disability insurance is typically offered through an employer. It is also provided by the national government through the Social Security Administration. Social Security Disability Insurance, or SSDI, is funded through your payroll taxes commonly known as “FICA” taxes. Additionally, some states also offer their own state-funded disability coverage. However, as with life insurance, if you think your employer, government, and state coverage is not enough for you and your family, you can get additional coverage through an individual disability policy by going directly to an insurance company (or an insurance agent). Approval for an individual disability policy will require underwriting.

Our Take-Aways

There are many risks in life, and there are many insurance products to protect against those risks. But life insurance and disability insurance are two insurance products that can be extremely important to an individual’s financial plan. This is especially true for younger individuals or families, or those who don’t have enough savings and assets to be considered “self-insured.”

Both life insurance and disability insurance can be vital components in a financial plan, but with all the options available, the decisions on the types or levels of coverage can be overwhelming.  It is important to focus on how much money or income you think you and your family will need to live over a certain period. You should remember that it is generally better to get insurance before you need it, while also keeping in mind that these types of insurance tend to get more expensive as you get older and as additional health issues arise.

Sources

¹Maleh, Johanna and Tiffany Bosley. “Disability and Death Probability Tables for Insured Workers Born in 1997.” Social Security Administration, October 2017.