Disability insurance

Also called income protection insurance

Insurance that replaces part of a person’s income if illness or injury prevents them from working.

What it means

Disability insurance pays a monthly benefit, usually a percentage of pre-disability income, when the insured cannot work because of a covered illness or injury. Short-term policies cover a few months; long-term policies can last years or until retirement age. Benefits begin after an elimination period, a waiting time set by the policy.

Definitions matter: own-occupation coverage pays if someone cannot do their specific job, while any-occupation coverage pays only if they cannot do any suitable work. Coverage is available through employers and individually. If an employer pays the premiums, benefits are generally taxable; if the person pays with after-tax money, benefits are generally tax-free.

Example

Suppose someone earning $6,000 a month has a long-term policy that replaces 60% of income after a 90-day elimination period. If an injury keeps them out of work, they would receive $3,600 a month once the waiting period ends.

How it’s used

Protecting income for workers without large savings
Self-employed people without employer coverage
High earners in specialized professions

Strengths and weaknesses

Strengths

Protects the ability to earn income, often a person’s largest asset
Benefits can last for years
Individual policies stay with a person between jobs

Weaknesses

Individual policies can be expensive
Replaces only part of income
Elimination periods and definitions can limit payouts
Employer coverage may be lost when changing jobs

Good to know

An emergency fund that covers the elimination period helps bridge the gap before benefits start.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.