Everything You Need to Know About Disability Insurance

When people think about protecting their financial future, they often focus on saving for retirement, investing prudently, or maintaining adequate life insurance. Yet one essential form of protection is frequently overlooked: disability insurance. If you rely on your income to support yourself or your family, disability insurance is one of the most effective tools available to safeguard your long-term financial stability. It also protects against a risk that is far more common than many people realize.

The Social Security Administration estimates that approximately one in four 20-year-olds will become disabled and qualify for Social Security disability benefits before reaching age 67. At the same time, about 65 percent of private-sector workers do not have long-term disability insurance. Disabilities can arise from illnesses, injuries, chronic conditions, mental health issues, or medical treatments that prevent someone from working, whether temporarily or permanently. And the financial impact of a disability can come from two directions – it reduces or eliminates the family’s income when the wage earner cannot work, and it drives up medical costs, often forcing the family to draw down their savings.

Despite these risks, income protection is one of the most overlooked components of a sound financial plan. Many individuals insure their homes, cars, and valuables, but underappreciate what is often their most valuable asset: the ability to earn a living. Disability insurance exists to make sure that if the unexpected occurs, you can continue paying your bills and protecting the financial progress you have made.

What Disability Insurance Covers

Disability insurance replaces a portion of your income if you are unable to work because of illness or injury. It is not intended to cover 100 percent of earnings. Instead, its purpose is to provide enough income to keep you financially stable during a period in which your expenses may rise due to medical costs, and your ability to earn money may decline.

There are two primary types of disability insurance: short-term and long-term.

Short-term disability typically provides benefits for a few months up to one year. It is designed for temporary conditions such as recovery from surgery, childbirth (depending on the policy), or injuries that resolve within a relatively short period.

Long-term disability offers protection for more persistent or permanent conditions. Benefits may last for several years, until a specific age (commonly 65 or 67), or even for life. For most individuals, long-term disability insurance is the more important safeguard because long-lasting disabilities pose the greatest threat to financial security.

Own Occupation, Any Occupation, and Split (Hybrid)

How a policy defines disability is one of its most important features because it determines when benefits are paid. The three primary definitions are own occupation, any occupation, and a split or hybrid definition.

Own-occupation policies pay benefits if you are unable to perform the material duties of your specific job, even if you can work in another field. For example, a surgeon with a hand injury may qualify for benefits even if he or she is capable of working as a teacher or consultant. This definition provides the strongest protection and is especially valuable for professionals with highly specialized skills who have undergone years of training.

Any-occupation policies require that you be unable to work in any job for which you are reasonably suited by education, training, or experience. Under this definition, the same surgeon might not qualify for benefits if he or she can perform another role, such as administrative or teaching work. Because insurers are less likely to pay long-term claims under this definition, premiums tend to be lower.

Split or hybrid definitions combine both standards. These policies typically use an own-occupation definition for an initial period and then shift to an any-occupation definition afterward. This approach provides time for the insured to adjust to new physical or medical limitations and, if needed, pursue job retraining or vocational rehabilitation. Some policies explicitly include benefits to support this transition.

Because the definition of disability directly affects eligibility for benefits, it is essential to review policy language carefully. Lower-cost coverage often comes with stricter definitions that may not provide meaningful protection when it is needed most.

Elimination Periods and Benefit Periods

Every disability insurance policy includes two important timing provisions: the elimination period and the benefit period.

The elimination period is the waiting period beginning upon injury or sickness, during which an individual is disabled but is not yet eligible to collect benefits from the insurance company. Short-term policies usually have elimination periods ranging from 5 to 30 days, while long-term policies commonly offer periods of 30, 60, 90, or 180 days. Longer elimination periods reduce premiums because you are effectively self-insuring for a longer duration. Ideally, your emergency savings should be sufficient to cover expenses during this interval.

The benefit period determines how long benefits will be paid once you qualify. Common benefit periods include two years, five years, to age 65, to age 67, or to age 70. Longer benefit periods cost more but are essential for protecting against long-lasting or permanent disabilities.

How Premiums Are Determined

Several factors influence the cost of disability insurance, including age, health, occupation, income, lifestyle activities, and the strength of the policy features selected. Younger and healthier individuals pay lower premiums, which makes securing coverage early particularly advantageous. Occupation class is another major factor; physically demanding or high-risk jobs typically result in higher premiums.

Disability insurance underwriting is more detailed than many people expect. Insurers generally examine medical history, two years of income records, and any activities that increase the likelihood of a claim, such as scuba diving, aviation, or international travel. Each insurer has different underwriting standards, which means that comparing offers can be very helpful.

In some cases, the final policy offer may differ from the applicant’s initial preferences. An insurer may limit the benefit amount, extend the elimination period, or modify certain policy features based on the applicant’s occupational or medical risk profile.

Additional riders can also influence the cost of coverage:

• A cost-of-living adjustment (COLA) rider increases your benefit over time if you remain on claim.

• A guaranteed renewable rider ensures that as long as you continue paying premiums, the insurance company must renew your policy each year and cannot change your coverage terms. While premiums may increase for an entire class of policyholders, your individual policy cannot be singled out for modification or cancellation.

• A future Increase option (FIO) rider allows you to increase your disability insurance coverage in the future without undergoing additional medical underwriting. As your income grows throughout your career, you can purchase more coverage up to specified limits, making sure your protection keeps pace with your earnings. This rider is especially valuable for early-career professionals whose financial responsibilities and income are likely to rise substantially over time.

• A residual benefit provision provides continuing benefits for an insured who returns to work but suffers a loss of income due to the disability.

• A partial disability rider provides partial payments if you are unable to perform at least one important duty of your normal occupation.

• A waiver of premium provision keeps the policy in force without requiring you to pay premiums while you are disabled.

These features add cost, but they significantly enhance the effectiveness of the policy.

Group vs. Individual Disability Insurance

Many workers have access to group disability insurance through their employer. This coverage is useful but often limited. Group policies usually have weaker definitions of disability, lower benefit caps, limited customization, and a lack of portability if you change jobs. Benefits may also be taxable if your employer pays the premiums.

Individual disability insurance offers stronger, customizable protection that remains in force regardless of employment changes. Benefits are generally tax-free when premiums are paid with after-tax dollars. For high-income earners, self-employed individuals, and business owners, an individual policy is often essential for adequate protection.

Tax Treatment of Disability Benefits

The taxability of benefits depends on how premiums are paid. If you pay premiums with after-tax dollars, benefits are typically received tax-free. If your employer pays the premiums or if you pay with pre-tax dollars, benefits are usually subject to income tax.

The Role of Social Security Disability Insurance (SSDI)

Some individuals assume that Social Security Disability Insurance will replace their income if they become disabled. While SSDI is an important part of the social safety net, it is not designed to fully replace earnings for most workers.

SSDI has a strict definition of disability: “you must not be able to engage in any substantial gainful activity (SGA) because of a medically determined or mental disability(ies) that is either: expected to result in death [or] has lasted or is expected to last for a continuous period of at least 12 months.” Approval rates are low, the application process can take many months, and the benefits are modest compared to most people’s pre-disability income. For these reasons, financial planners generally view SSDI as a fallback rather than a primary source of protection.

Why Disability Insurance Is Essential

For most working adults, the ability to earn income is their most valuable financial asset. Over a lifetime, total earnings often exceed the value of a home, investment portfolio, and retirement accounts combined. Disability insurance protects this asset by ensuring that an illness or injury does not derail long-term financial goals.

Without coverage, many individuals are forced to deplete savings, take on debt, or liquidate retirement accounts prematurely. For households with dependents, the financial stakes are even higher. Disability insurance provides stability and protects the household’s standard of living during periods of disability.

How Much Coverage You Need

Determining the appropriate amount of disability insurance requires thoughtful analysis of income, expenses, existing coverage, savings, and long-term goals. As a general guideline, most people should aim to protect 60 to 70 percent of their gross income. Because benefits from individual policies are typically tax-free, replacing 100 percent of your income is not usually necessary.

Insurers limit the total amount of coverage available to avoid situations in which a policyholder could earn as much or more while disabled. If employer-sponsored coverage is insufficient or if benefits are taxable, an individual supplemental policy can help fill the gap.

Final Thoughts

Disability insurance may not receive the same attention as investment planning or retirement saving, but it is a cornerstone of long-term financial security. A well-constructed policy ensures that your financial life remains stable even when your health is challenged. Understanding the key definitions, features, and cost factors empowers you to select coverage that aligns with your needs and goals.

If you would like help reviewing existing disability coverage or determining whether additional protection is appropriate, a financial planner can guide you through the process and ensure that your income remains protected for the long term.

If you are unsure about your disability insurance needs, schedule a complimentary, no-obligation call with us. To learn more about how Holzberg Wealth Management can help you achieve your financial goals, learn more about us here!

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About the Author

Holzberg Wealth Management is a family-owned and operated financial planning and investment management firm based in Marin County, CA. As your financial advisors, we serve you as a fiduciary and are fee-only, so we never receive commissions of any kind. We help individuals and families like you in the greater San Francisco Bay Area and nationwide with the financial decision-making process to organize, grow, and protect your assets.

** This writing is for informational purposes only. The author and Holzberg Wealth Management do not guarantee or otherwise promise any results that may be obtained from using this report. No reader should make any investment decision without first consulting their financial advisor and conducting their own research and due diligence. These commentaries, analyses, opinions, and recommendations represent the personal and subjective views of the author and do not constitute a recommendation, offer, or solicitation to make any securities transaction. The information provided in this report is obtained from sources that the author believes to be reliable. External links to third parties are being provided for informational purposes only. Holzberg Wealth Management is not affiliated with the third-party websites linked to, unless otherwise explicitly stated, and does not constitute an endorsement or approval by Holzberg Wealth Management of any of the third party’s products, services, or opinions.