This is the 5th in a series on disability insurance. Previous installments can be found here. This will discuss how much disability insurance to buy, how to pay for a policy, and when to cancel the policy.
How much coverage
I had a recent question from a reader:
I have been covered during residency and fellowship under a free group DI plan- 55% of salary…If I stay as an attending it shifts to 66.6%… If I get a supplemental policy during fellowship, how much additional coverage should I be aiming for?
It’s a good question, but unfortunately, one that I found myself unable to answer, at least without more information. Determining how much coverage to purchase is a very individual decision, much like buying life insurance. While one doctor might want enough life insurance to pay off the mortgage and cover 5 years of living expenses so the younger children are in school and his wife can go back to work, another might want to be able to provide for her husband to never have to work again and pay for expensive colleges for her two children. Obviously, the second will want to purchase much more coverage than the first. It is the same with disability insurance. The question isn’t how much of your salary you want to replace, it’s how much you’ll need to live on.
If your current after-tax living expenses are $10K a month, you may need $10K a month after-tax, preferably indexed to inflation. Since disability insurance is so expensive (generally you pay 2-5% of the coverage amount-$10K per month of coverage may cost up to $500 a month), you may be tempted to cut a few corners. “Yes, we’re spending $10K/month now, but if I became disabled, we could get by just fine on $7500”, you may say. You really need to think through the scenario. If you become unable to work tomorrow, what will your family do? Will your spouse go back to work or pick up more hours? Will you realistically be able to do some or all of the work of a stay at home spouse? Two physician spouses may realize they could easily live on just one salary, and thus opt not to get disability insurance at all, or at least smaller policies than a single physician household may choose. One other consideration is that most disability policies stop paying at age 65. If you don’t have a decent nest egg, and cannot live on social security in retirement, you’ll need to have enough disability coverage that you can save some of it for retirement and live on the rest. Think these scenarios through carefully, then err on the side of buying a little too much rather than not enough. As the years go by inflation will make the benefit seem smaller and smaller. Even if you purchased a cost of living adjustment rider it doesn’t start adjusting until you become disabled.
There are limitations to how much disability insurance you can purchase. As a general rule, the companies will limit you to replacing about 2/3 of your salary, with a maximum of $15-17K. The companies don’t want it to be more attractive to you to not work than to work. 2/3 of a resident salary isn’t much to live on for the rest of your life, so a student, resident, or fellow should buy as much as they’ll sell you (and with a future purchase option in addition.) If you’re currently living on $15-30K/month, you probably also want to get the maximum available to you, as a disability is going to have a severe impact on your standard of living. But most attending-level physicians can probably get by on less than the maximum amount, and this is a good place to save a little money you can put towards retirement.
In my case, my disability insurance policy is the same one I bought as a resident, but I have exercised the future purchase options to the maximum, and now carry a total of $7500/month of post-tax benefit. That is enough that it would cover our current living expenses, but it would not allow us to save for retirement. However, I have a nest egg that combined with 30 years of compounding at a reasonable rate, and combined with social security, would allow us a comfortable, although not extravagant retirement. I anticipate another income increase in a year or so and will probably purchase an additional policy at that time, perhaps for another $2500-5000. This policy would be more expensive than my current one due to increased age, so it would be the first one I cancelled when I no longer needed it. I would buy it from a different company than my current one, to provide some diversification benefit. I would also purchase it through my business so I could deduct the premiums as noted in the next section.
Pre-tax vs Post-tax
Many attending physicians can make the decision between using a pre-tax vs a post-tax disability policy. If you pay for the premium post-tax, your benefits are post-tax. If you deduct the premiums as a business expense (you must have a business to do this obviously), you’ll have to pay tax on the benefit payments if you ever become disabled. This is an individual decision, but in the end I think it is usually pretty close to a wash. If you are underinsured (like most residents and fellows), you should probably go for the post-tax policy. You qualify for the same amount, and post-tax money is obviously worth more than pre-tax. If you are not underinsured, consider that if you’re disabled, you’ll have less income than you have now and may be in a lower tax bracket. So you can take the deductions in a high tax bracket, and if disabled, you can then pay taxes on the benefits in a lower bracket. This is particularly attractive to many physicians when they consider the odds of acquiring a disability are in their favor. (Odds of a disability lasting longer than 5 years are around 1 in 7.) If you are in a high tax bracket, a maximum size POST-TAX policy (2/3 of income) may mean that you have no drop (or even an increase) in your standard of living with a disability. For those who are not looking for a maximum size policy I recommend you get a bigger policy than you otherwise would, but pay for it pre-tax to take advantage of the sure tax deduction, while only taking a 1 in 7 chance of having to pay taxes on the benefits.
Monthly vs Annually
Many physicians will find it most convenient to pay their disability and life insurance premiums on a monthly basis. Always ask if there is a discount for those who pay on an annual basis; there almost always is. My policy gives me a 5% discount to pay annually. One of my life insurance policies offers a similar discount. It’s tough to get a guaranteed 5% return these days in the market. Good things happen to those who can budget. I just put 1/12 of the premiums aside each month and when the policy comes due each year I pay it in one lump sum.
When buying insurance, you want to insure against financial catastrophe, not trivial expenses like breaking your iPhone. It would be a financial catastrophe for a 35 year old physician to develop a life-long disability. Hopefully it wouldn’t be a similar catastrophe for a 60 year old physician to develop the same disability. The older doctor, if he has saved diligently and invested wisely, should be financially independent, or very close to it. There should be some amount of net worth at which an investor can cancel his disability and term life insurance policies. When you get there, give yourself a little cushion on that number (in case of market fluctuations), get your routine medical screenings done (just in case you have colon cancer which will disable you in a few months and just don’t know it yet), take a deep breath, and cancel your policies. You may be spending $3-900 a month on insurance you no longer need. Even if you want to keep working once you reach financial independence, you don’t need to insure against non-catastrophic financial concerns.
Stay tuned for part 6, where we’ll discuss group disability policies, key-man policies, and other “special” kinds of disability insurance.