Long-term Disability (LTD) Insurance: Protect your most valuable asset (YOU)

For most Americans, Labor Day marks the last hurrah to Summer before we officially re-plug back into the work matrix. However, I want to use this recent holiday to bring up a financial planning topic that’s rarely discussed and, rarer still, executed: long-term disability (LTD) insurance.  (I know, yuck! I’ll try and make this quick and painless.)

When it comes to financial planning, for most people, the end goal is typically financial independence and/or retirement.  (What’s my number?)  But, by focusing on building up assets for tomorrow, many of us overlook the most valuable asset that we have today – our human capital.  To build up assets to eventually replace our salary when we no longer can or want to work, most of us need to use our human capital to earn, save and invest.  But, based on my experience, prospects and clients rarely bring up LTD insurance as a part of their financial picture.  My guess is, like estate planning, LTD insurance seems foreign; complicated; potentially unnecessary; portents personal misfortune. (Why go there?) As often the case, however, the most important topics are often the most uncomfortable to discuss. What would happen if you can’t work for a year…or a lifetime?  Who will support you and/or your family?  How will you get by?  Let’s start the conversation…                

What is LTD insurance?  

LTD insurance protects your human capital (or potential income).  Should you become disabled and can’t work for an extended period of time, LTD benefits will kick in to help pay for living expenses.  The typical LTD policy supplements 40-60% of gross income and begins after the policy’s waiting (or elimination) period, usually 90-180 days.  So, if you earn $100K/yr and suffer from a qualified disability for longer than your policy’s waiting period, then you will receive LTD insurance benefits (assuming 60% of gross income) for the duration of your disability, which could be until you reach age 65, depending on your policy. This means you’ll receive a $5K/month “pay check” to help you get by until you get back on your feet again (literally).                         

Who needs LTD insurance?  Why?  

According to the Social Security Administration, 25% of all 20-year-olds now will need LTD insurance before age 67 (retirement).[1]  Moreover, women typically file more claims than men as we’re more inclined to see a doctor.  Here’s the list of top disabilities for women: arthritis, rheumatism, heart disease, cancer, mental health issues, diabetes, and nervous system disorders.

As is the case, prime candidates for LTD insurance are those in their prime working years (20s – 40s); highly educated and/or skilled; have yet to build up a lot of assets; have debts and/or dependents.

How long do you need LTD insurance?  

As with (term) life insurance, LTD insurance is more critical in certain stages of life than others.  As mentioned, if you’re just starting out, highly skilled, have debts and/or dependents and have not had enough time to build up other assets (e.g., portfolio, house), then LTD insurance is critical for you.  You need to protect your earnings potential so you can build up additional income replacement assets.  One of the best places to build up those assets quickly and tax efficiently are in various (employer-sponsored) retirement and investment accounts: 401k; 403b; Roth 401k; Roth 403b; Roth IRA; HSA; brokerage account. As your portfolio grows, you may consider slowly reducing your need for LTD insurance by potentially lowering benefits from say 60% to 50% of  gross income.  Reason being, your portfolio can supplement some of your income needs should you become disabled.  (See table below for potential annualized return and withdrawal rate for different size portfolio – 75/25 mix.)   

*Based on historical return, a diversified, moderately invested portfolio (75 % stocks and 25% bonds + cash), produce 7% in annualized return. 

**Based on the Trinity Study, the safe withdrawal rate from such a portfolio is 4% annually for at least 30 yrs.

NOTE: Social Security Administration also provides disability insurance, but qualifying for benefits can be a lengthy, arduous and complicated process.  Moreover, benefit is typically small.

What to look for in LTD insurance policy? 

Ideally, here are the key coverage (and terms) to look for in LTD insurance: