By Eric Rosenberg, WCI Contributor
According to the Centers for Disease Control (CDC), 61 million adults in the United States live with a 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. Again, 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. A $200,000 portfolio and no debt at 33—not to mention he reads this blog.
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.
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 on in their careers.
Graded Premium Disability Insurance
Graded premium disability insurance starts with a lower premium that goes up over time. For example, you may see your premium increase annually or step up on a regular schedule, like every five years.
Graded premiums are beneficial early on, as 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.
What Is the Difference Between Graded and Level Disability Insurance?
As you can extrapolate from the explanations above, the most significant difference in level term and premium term disability insurance 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’re able to 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 cancel it and get a new level policy later on. However, it may cost more in the future when you’re older and more likely to suffer from health conditions.
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 term 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.
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.
Have more questions about disability insurance and what kind of policies would be the best for you? Hire a WCI-vetted professional to help you sort it out.
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Thanks for the post, very timely for me. I’m a military dentist in mid-30’s with a healthy/WCI influenced retirement portfolio. I got a graded premium disability policy with low coverage right before starting active duty in my mid-20’s. My insurance agent is now suggesting I go to a level-term premium.
Trying to decide if its worth it or not… Would the option of converting the current policy to level term and then adding a graded premium policy if I get out of the military in a few years make the most financial sense?
It’s always tough to tell if the insurance industry is actually looking out for your best interest or just trying to sell you something. Grateful to the WCI community for improving financial literacy!
Appreciate any thoughts you may have!
When do you expect to be FI? If relatively soon, why get a level premium policy?
FI is currently planned for 60….although currently on track to hit this sooner by several years but still likely 20+ years away. As you say, my crystal ball is cloudy.
The benefit for the level term disability policy is being kept low while I’m in the military but plan to increase it significantly when I leave active duty.
Would ‘splitting the difference’ by converting my current low benefit low cost graded premium to a level premium (for a slight cost increase) and then adding a new graded premium policy when/if I leave active duty in a few years make sense?
Thank you!
Probably doesn’t matter too much what you do there, but if you’re planning to keep the policy to 60ish the level premium is likely a reasonable option. For a doc that cancels it at 45? Not so much.