According to the Centers for Disease Control (CDC), as many as 90 million people in the United States have some type of disability. Disabilities affect two in five adults age 65 and older. If you’re under 40 years old, there’s a roughly 50% chance you’ll be disabled at some point in your life. For those unpredictable times when a disability may impact your income, there’s disability insurance. Today, we'll talk about the differences between graded premiums and level premiums.
Disability insurance is a critical financial tool for protecting yourself and your family if your income suddenly stops. It's especially essential for physicians, even if it's early in their careers, to procure disability insurance. It's estimated that one in seven doctors will become disabled sometime in their careers, and the greatest financial risk for physicians is to lose the ability to work in their high-income profession for decades. Here’s a closer look at what the difference is between graded premiums vs. level premiums and how you can decide on the right combination of disability insurance for your unique needs.
Getting Started with Disability Insurance
Disability insurance (DI) comes in two main varieties. Short-term disability insurance benefits typically begin immediately after becoming disabled and last for a period of three months to one year. Long-term disability insurance requires a waiting period and lasts for an extended period. Long-term benefits often last for several years or until the disability ends.
A White Coat Investor reader wrote in years ago to ask about two alternatives presented when picking disability insurance policies:
“Wanted to ask you about going with a graded vs. level premium for my DI. I am 33, just starting my practice, and expect to have a significant retirement account in the future. Currently no debt and approximately $200,000 in my portfolio.
What would you do in this situation? I read on your blog how you would consider dropping the DI in your early 50s. If that is the case [does it] make sense to just keep the graded premium as the benefits of going with level do not arrive until around age 53?”
First off, this reader is obviously doing something right with a $200,000 portfolio and no debt at 33.
When shopping for disability insurance, it’s definitely worth asking about graded premium and level premium policies to compare. If the total cost of the premiums is less for a graded premium option between the time of purchase and the most likely time of cancellation, then it's just about a no-brainer to take it.
Obviously, something could happen. Your earnings could go down. You might get divorced. Your investment portfolio may underperform your expectations. But it seems a pretty good bet to make if you're a white coat investor.
Tip: You should also consider life insurance to protect your family in the event of a worst-case scenario.
More information here:
The Physician’s Guide to the Best Disability Insurance Companies
Why You Need Disability Insurance (and I Need Shoulder Pads)
Level Premium Disability Insurance
With a level premium disability insurance policy, your premium payment is locked in for the policy's term. Whether you pay monthly, quarterly, semi-annually, or annually, your premiums will never change.
This may be best for someone who doesn’t think their income will change much in the future or who wants the stable, predictable payment structure of the level premiums. Level premiums are also advantageous for anyone who plans to keep the policy for a very long time, as they’re able to avoid the higher-cost premiums later in their careers.
Graded Premium Disability Insurance
Graded premium structures on individual disability insurance and the step rate option on association disability insurance both increase over time. Companies like Guardian and MassMutual offer graded premium options, where the premium increases each year, while Ameritas, Principal, and The Standard do not offer graded premium as an option. Some association plans, like those offered through the American Medical Association and other associations, premiums usually increase every five years under the step rate option.
Graded premiums are beneficial early on, since your costs are lower. If you’re a resident who expects a higher income over time, graded premiums may be easier on your budget. However, after a few decades, you may end up with a much higher payment than what it initially cost. It may make sense for a resident who starts with a graded premium structure to level out their premiums after becoming an attending.
What Is the Difference Between Graded and Level Disability Insurance?
As you can extrapolate from the explanations above, the most significant difference in level and graded disability insurance premium structures is how you pay. With level premium disability insurance, your premium never changes. With graded disability insurance, your premiums start lower and increase over time.
To decide which is better for you, consider a couple of future scenarios.
First, think about how long you may need to keep disability insurance before you can self-insure, which means you have enough savings and investments that you no longer need insurance if you become permanently disabled. Let’s assume you plan to keep your disability insurance until age 55.
In this case, you can easily add up your total premiums if you pick a level policy or a graded policy with the same benefits. You are likely best off with the policy that costs less in that period.
Second, consider your potential disability needs and budget. It’s critical to have enough disability coverage to meet your needs. You may find graded disability insurance more attractive right now. You could always request to level out your current premiums down the road. Keep in mind, those premiums, which are typically priced at your new attained age, will be more expensive than the level premium you were probably presented with when you first took out your policy. However, buying disability insurance early on, even if with a graded premium structure, helps lock in your medical insurability if your health changes down the road.
There’s also no rule saying you can’t get both. You may find that a lower-value level premium disability policy pairs well with a graded policy. Eventually, you can cancel the graded premium policy when you no longer need it. And finally, years in the future, as you reach financial independence or retirement, you can cancel all disability insurance. This can be a good idea since the total benefits a policy could potentially pay are also dropping throughout your life (since the policy will generally only pay until you are in your mid to late 60s). If you are one of those white coat investors who will hit financial independence by mid-career, you are likely to come out ahead using graded premiums instead of level premiums.
More information here:
Why Do Some Doctors Get Declined for Disability Insurance?
Focus on the Dollars and Cents
Medical professionals can take a pragmatic look at the likelihood of becoming disabled. While we all hope and plan to stay healthy for years to come, an unexpected accident or illness could quickly derail our financial plans. That’s why disability insurance is so important.
When shopping for disability insurance—or any other insurance—try to take emotion out of the equation. By understanding your total long-term costs, you can make the best insurance decisions.
What do you think? When you first bought disability insurance, was it graded premium or level premium? Was that the right decision for you? Would you do anything different today?