You’ve heard this story before.

When Jane emerged from her divorce, she realized she had to rebuild her life. Her 24-year marriage to the man she met in college was over. Her two children were out of the house and off to college. At age 47, she found herself in a house that had been her home for over a decade, and which suddenly felt empty.

Jane was able to negotiate a settlement with her ex-spouse that included alimony payments of $2,500 per month for the next 15 years. While that was comforting, she quickly realized she could not live on those payments alone. She would need go back to work.

Fortunately, she had been working part-time while raising their kids. So, her skills as an interior designer hadn’t been completely forgotten and she felt confident that with a few professional courses she would be back up to speed. Then she would need to decide whether she should look to get hired by a large firm that could provide her a salary and benefits, or take the riskier route of expanding her own solo practice. While the latter would give her more personal freedom, the former would give her the economic stability she really wanted at this time in her life.

Jane’s situation is common for women re-entering the work force after lengthy marriages and years spent at home raising children. In Jane’s case, she has professional skills and should be able to resume her career as an interior designer. The salary range for an interior designer in Portland, Oregon is $36-$65,000, according to Glassdoor. Of course, that is just a range, and so some people make less and some much more than that.

We are sharing this vignette, because there is an issue somewhat hidden that needs attention. Jane has to return to work in order to meet her own income needs. Let’s assume she earns $50,000. What happens if she becomes sick or gets hurt, and cannot work? If she works for a large company, she may receive some sick leave pay. She might receive 2 weeks’ salary. But it is not a given that she will receive disability benefits. If she’s self-employed and can’t work because of illness or injury, she will not earn any income.

What’s the solution? Income replacement insurance, otherwise known as disability insurance. This insurance will pay a benefit to Jane if she becomes disabled and can no longer work. If Jane is self-employed and has paid the insurance premiums, the benefit is tax-free. If she is an employee and her employer has paid the premiums, the benefit Jane receives will be taxable.

What are the most important features of disability insurance? The benefit amount is how much Jane will receive if she becomes disabled. The benefit amount is commonly stated as a dollar amount per month. In Jane’s case, her benefit might be $2,500 per month. The waiting period is the amount of time between the occurrence of the disability and the beginning of benefit payments. Waiting (or “elimination”) periods range from 30 to 180 days. The longer Jane is willing to wait for benefits to commence, the lower the insurance premium will be. The benefit period is the length of time over which benefits will be paid. Common benefit periods are 2 years, 5 years and “to age 65”. The longer the benefit period, the higher the premiums will be. The most important element of a disability insurance policy is the definition of disability. The policy language will spell out what exactly must happen for Jane to be considered disabled and receive a benefit. The stronger the definition, from Jane’s perspective, the better the coverage and the more expensive it will be.

What about Social Security? Doesn’t it pay a benefit to people who become disabled? It does. However, the problem with Social Security’s disability insurance is that the definition is draconian. Social Security Administration states: “The law defines disability as the inability to engage in any substantial gainful activity (SGA) by reason of any medically determinable physical or mental impairment(s) which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months.” In Jane’s case, if she were to become disabled and no longer able to work as an interior designer, she might still be able to do some other form of work, perhaps in retail, a call center or a fast food restaurant. None of those jobs would pay her as well.

How important is this really? Disability is far more common than most people think. According to the Centers for Disease Control and Prevention, one in four adults – or over 61 million people – in the United States have a disability that “impacts major life activities.” The most common functional disability was related to mobility. Let’s assume Jane becomes disabled and cannot return to work. If she would have earned $50,000 each year between age 47 and age 65 and we do not adjust for wage increases, her lost earnings would total $900,000. The figure is much larger, if we assume she receives 3-5% annual salary increases.

Jane’s most valuable asset is her ability to work. And that is also the case for the vast majority of Americans who do not have substantial assets. We generally insure our valuable assets … houses, cars, jewelry, art and collectibles, etc. We also need to insure our ability to work. We do so with disability insurance.

Note: Springwater Wealth Management does not sell disability insurance or any financial products. However, we advise our clients on managing risks such as disability. If you or your clients have questions about disability insurance, please contact us for assistance.

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