Disability income insurance: What it is & how it works

No one expects to get sick or injured. But 1 in 4 of today's 20-year-olds can expect to experience a disabling event before they reach retirement age, whether it's for a few weeks or a long-term change in their ability to work. That's why disability income insurance is more than just a contract—it's a valuable way to protect your income.

Understanding disability income insurance can help you know your options and develop an income security strategy that can give you confidence in your financial future.

Disability income insurance, also known as disability insurance, replaces a portion of your income if you experience a nonwork-related injury or illness that prevents you from working.

"Often the word 'disability' conjures up pictures of a catastrophic, permanent injury," says Don Campfield, a business development consultant with disability insurance expertise in Thrivent’s Health Center of Excellence. "However, more often," he says, "it’s nearly any condition that can keep you out of work for a period of time, potentially impacting your finances." (Think a broken bone that bars you from physical duties of your job, or a diagnosis that keeps you from work due to multiple rounds of treatment.)

Disability insurance steps in to help you:

• Replace income.
• Preserve your savings.
• Pay expenses.

You can get disability income insurance on your own through a variety of private insurers, or it may be offered as an employee benefit—though your employer coverage alone may not be enough.

Most disability insurance operates similarly regardless of where the coverage comes from. If you have obtained it through a private insurer, however, you'll likely have more options to customize it to your needs.

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While many employers offer disability income insurance, it may not be comprehensive. Employers typically offer this benefit through group coverage. This bulk purchasing may keep premiums low, but you won't have control over your policy or be able to take it with you if you change jobs.

In addition to its lack of portability, your benefit may be taxable if your employer pays the premiums. This further reduces your total payout.

“On average, your group disability insurance policy may cover up to 60% of your gross income if something should happen to you,” says Chad Masche, market developer in Thrivent’s West Advisor Group in Arlington, Washington. "But, because your employer is paying for the policy, the benefits are typically taxable, so you’re bringing home even less. Which brings up an important question: What would you have to change if you were only bringing home potentially half your paycheck?"

Purchasing supplemental disability income insurance can help close that income gap while also giving you flexibility and coverage from job to job.

• Learn more: How much disability insurance do you need?

Typically, disabling experiences are injuries or illnesses. When you submit a claim, your physician and your employer will fill out specific forms showing the extent of your disability and how that disability limits your ability to work. Updates may be necessary if your condition changes or if your expected return-to-work date changes.

Most disability insurance contracts have an elimination period, which is essentially a waiting period before your coverage kicks in. Your options will vary by provider, but typically the elimination period is between 1-24 months. Generally, the longer this period, the more affordable your premiums. If you know you want coverage quickly, however, you can choose a shorter elimination period.

In general, most people find that disability insurance costs between 1% and 4% of their yearly income. It's possible to keep your costs low. You can lower your premiums by choosing a shorter benefit period, a smaller total benefit or a longer elimination period. If you have some savings to lean on in the event of a disability, you may not need as much insurance coverage overall.

While disability income insurance has familiar features across the various available options, you can tailor your benefits to what you most want to protect. For instance, you can choose a shorter benefit period focusing on an acute recovery period and bridging the gap between periods of employment, or a longer benefit period that would potentially cover you during a chronic condition or long-term change in working capacity.

While these aren't two separate kinds of insurance, tailoring your policy toward one or the other goal will typically result in your insurance being either considered short-term or long-term.

Short-term disability insurance refers to insurance with a benefit period of only a few months, sometimes up to a year or two. The elimination period, however, is usually short—from a few days up to a month. Short-term disability is meant to be used during recovery from a minor illness or injury, not for a permanently disabling experience.

Long-term disability insurance offers a benefit period of multiple years, sometimes even until retirement age. As a result, the elimination period is longer. You may have to wait a few months before your coverage goes into effect.

To choose how much disability insurance you need, first review your finances. From there, weighing your options and talking with a financial advisor can help you determine which disability insurance features work best for you.

The biggest factors to consider are:

• How long you want benefits to be available.
• How long you're willing to wait for those benefits to kick in.
• What percentage of your income you may need to cover living expenses.

Keep in mind that you may have more medical bills than usual due to the disability.

Depending on your provider, you may also have the option to select disability insurance riders, or add-ons that allow you to customize your coverage. For example, if you are disabled and using the benefit, a cost of living rider will grow the benefit over time to keep up with inflation. And a future purchase option (FPO) benefit allows you to increase your coverage down the road without an additional medical exam. These are optional, but they're worth looking into as you establish an income protection plan.

It's easy to overlook protecting your income, but it's the one asset that makes obtaining—and keeping—everything else possible. Knowing you have income replacement in the event of a serious injury or illness can give you confidence that your family will be well cared for.

To explore how disability income insurance can fit into your plan for the future, connect with a Thrivent financial advisor near you.