February 12, 2008

Protecting Your Income Source

When you think of insurance coverage, the two most common types - home and car insurance - are often the first that spring to mind. Because the mortgage company requires the former and the law requires the latter, you don't have much of a choice when it comes to deciding whether to be insured. However, it's your ability to earn an income that allows you to afford these items. In fact, without earning potential, it would be difficult for many of us to maintain our homes and automobiles while still providing for our families. The solution for supplementing this missing income in the event of a permanent or temporary disability is known as disability insurance. Here we explain why disability insurance should be an integral part of your financial plan and what you'll need to consider when choosing a policy to protect your income.

Social Security and Disability

Many U.S. workers take disability risk management for granted because they assume that the Social Security system will take care of everything should they become disabled. Contrary to popular belief, qualifying for Social Security disability benefits can be quite difficult, and it often takes a long time for the benefits to start. To qualify, you must prove that you are incapable of performing any job, not just your primary occupation. As long as you can be gainfully employed, even if it's working for minimum wage, you won't be able to collect on Social Security disability.

The Social Security Administration (SSA) will consider a person to be "disabled" if all of the following requirements are met:

  1. He or she lacks the ability to engage in any substantial gainful activity (SGA).
  2. The incapacity is due to one or more medically determinable physical or mental impairments.
  3. The incapacity has lasted or can be expected to last for a continuous period of at least 12 months or to result in death.

In order to meet the requirements for disability coverage under Social Security, applicants must have worked at least 20 out of the last 40 calendar quarters immediately preceding the onset date of the disability to be covered. Passive income activity, such as investments and sick pay would not be considered gainful activity income. However, if you claim disability and are earning income of more than $860 a month (in 2006), this will typically lead to a declined claim because it would be considered substantial gainful activity. Even if you are eligible for benefits, it's highly unlikely that the benefit will meet your financial obligations - the maximum payment for a 30 year old who earned $70,000 per year before becoming disabled is only $1,600 per month.

Protecting Your Family and Income

When reviewing your risk management objectives, you need to take a close look at your emergency reserves and liquidity capabilities. (To learn more, see Build Yourself An Emergency Fund.) If you became disabled and qualified for a maximum SSA $1,600 monthly payment, would this be enough income to support your budget? According to a 2004 report by the U.S. Census Bureau, the average real median monthly household income was $3,700 in 2004. This data strongly suggests that a supplemental income source would be a necessity for many Americans if they were to become disabled. It's important that you understand the benefits provided by your company, as you may be covered under a short-term or long-term disability policy through your employer benefits plan. When it comes to disability insurance, "short-term" refers to periods of 90 days or less, while "long-term" refers to periods of more than 90 days.

Once you've determined what disability risk management you have in place, you can then make an educated decision as to whether you are fully insured or underinsured. If you lack the appropriate income replacement, you may want to consider buying a personal disability policy. As with most types of insurance, the older you get, the more expensive the coverage will become. Therefore, you may want to acquire a policy now while you are illness and accident free. Whether your benefits are taxable will typically depend on how the premium is paid. In most cases, if you pay the premiums with after-tax dollars, the benefit received will be tax free. However, if your employer pays the policy premiums for you, then the benefit will likely be treated as taxable income when paid to you. (For further reading, see Insight Into Insurance Scoring.)

Here are some questions to consider when looking into disability insurance:

How much coverage should you consider?

You should consider obtaining enough coverage to maintain your family's current standard of living. While gauging your required amount of replacement income, it is best to err on the side of conservatism. However, recognize that you may save on certain living expenses (such as driving to and from work every day) that may reduce the amount of replacement income you will need to maintain your family's lifestyle. In short, be sure to consider both sides of the coin when assessing your coverage needs.

What is an "elimination period"?

The elimination period is the amount of time that you must wait before your benefits kick in. The typical elimination or waiting period for most policies is 90 days, which means you must have your own resources for the first 90 days of your disability. Be sure to incorporate your insurance plan's elimination period into your personal saving requirements.

For how long will an individual policy pay a benefit?

Since there are many different options for this, you can select the period of time for which your benefit will last. The best policy would entail benefits being paid until you reach age 65, at which time retirement benefits should become accessible to you.

What is the difference between "own" and "any" occupation?

If you're looking at policies that allow you to select between "own occupation" or "any occupation", you'll want to consider a plan that defines "disabled" as unable to continue work in your current profession - known as "own occupation". Otherwise, if you choose "any occupation", you'll need to be unable to perform any type of work in order for the policy to pay any benefits.


Many years ago, there were 535 disability insurance companies. That number dropped to 390 in 1990. In 2003, the number had dropped even more, to just 26 disability insurance companies! According to a 2004 Disability Status Report by Cornell University, only about 27% of American income earners had disability insurance, while more than 20 million of the nearly 168 million working-age population reported one or more disabilities. As you can see from the decline in the number of insurance companies writing disability insurance, the cost and frequency of disabilities among workers appears to be increasing. What would happen to your household income if you became disabled for a long time? Hopefully, you and your family would be taken care of, but if you're not sure that's the case, now might be the time to cover that risk. After all, part of being a savvy investor is making sure that your family is not unduly burdened by risks you can't afford to take.

Fifteen Insurance Policies You Don't Need

Fear of the future sells insurance. Because we can't predict the future, we want to be ready to cover our financial needs if, or when, something bad happens. Insurance companies understand this fear and offer a variety of insurance policies designed to protect us from a host of calamities that range from disability to disease and everything in between. While none of us wants anything bad to happen, many of the potential catastrophes that happen in our lives are not worth insuring against. In this article, we'll take you through 15 policies that you're probably better off without. (To learn about the basics of insurance, see Understand Your Insurance Contract and Exploring Advanced Insurance Contract Fundamentals.)

1. Private Mortgage Insurance

The infamous private mortgage insurance (PMI) is well-known to homeowners because it increases the amount of their monthly mortgage payments. PMI is an insurance policy that protects the lender against loss when lending to a higher-risk borrower. The borrower pays for this insurance but derives no benefit. Fortunately, there are several ways to avoid paying for this unnecessary policy. PMI is required if you purchase a home with a down payment of less than 20% of the home's value. The small down payment is viewed as putting you at risk of defaulting on the loan. Put down at least 20% and the PMI requirement goes away. Alternatively, you can put down 10% and take out two loans, one for 80% of the sale price of the property and one for 10%, although interests rates can prevent the economics of this maneuver from working out in the homeowner's favor. (To read more about mortgages, see Understanding the Mortgage Payment Structure, To Rent or Buy? The Financial Issues - Part 1 and Part 2.)

2. Extended Warranties

Extended warranties are available on a host of appliances and electronics. From a consumer's perspective, they are rarely used, particularly on small items such as DVD players and radios. If you purchase a reputable, brand-name product, you can be fairly certain it will work as advertised and that the extended warranty is statistically likely to be unnecessary. If you spend $5,000 on a giant, flat-screen television, the policy is still unlikely to pay off, but might make you feel better. For everything else, forget it.

3. Automobile Collision

Collision insurance is designed to cover the cost of repairs to your vehicle if you are involved in an accident. If you have a loan out on the car, the loan issuer is likely to require that you have collision insurance. If your car is paid off, collision is optional; therefore, if you have enough money in the bank to cover the cost of a new car, collision insurance may be an unnecessary expense. This is particularly true if you are driving an old car, because cars depreciate so quickly that many vehicles are worth only a fraction of their purchase price by the time the loan is paid in full. (To find out more about car insurance, read Shopping For Car Insurance.)

4. Rental Car Insurance

Most auto insurance policies offer additional coverage for the cost of car rentals, touting it as a useful feature if your car is ever involved in an accident and needs to spend some time in the repair shop. This may sound like a good idea, but in reality, most people rarely rent a car, and when they do, the cost is relatively low and hardly worth insuring against. Although rental car insurance is relatively inexpensive, amortized over the course of a lifetime you are still likely to spend far more than you will benefit.

5. Car Rental Damage Insurance

Many auto insurance policies already cover rentals, so there's no need to pay for this twice. Check your policy before you pay. Depending on where you rent the vehicle, you may also be able to pay a small fee for insurance on your rental when you pick it up at the rental center. If this fee is less than what you'd pay for a year in your old policy, choose the fee over the policy. (To read more, see Travel Tips For Keeping You And Your Money Safe.)

6. Flight Insurance

Flight insurance coverage is completely unnecessary. Despite media portrayal, airline accidents are relatively rare, and your life insurance policy should already provide coverage in the event of a catastrophe. (For more information on life insurance, see How Much Life Insurance Should You Carry?, Life Insurance Distribution And Benefits and Life Insurance Clauses Determine Your Coverage.)

7. Water Line Coverage

Water companies have made an aggressive push to sell policies that cover the repair of the water line that runs from the street to your house. The odds are in your favor that you will never use this coverage, particularly if you live in a newer home. If you live an average suburban neighborhood and you do need to repair the water line, the distance to the street is short, the likelihood of a problem is low and repair costs are a few thousand dollars or less. The same goes for policies offered by other utility companies.

8. Life Insurance for Children

Life insurance is designed to provide a safety net for your heirs/dependents. Because children don't have heirs to worry about and, statistically speaking, most kids will grow up safe and healthy, most parents should not purchase life insurance for their kids. Instead, use the money that you would have spent on life insurance to fund an education plan or an individual retirement account (IRA). (To read more on saving money for your kids, see Investing In Your Child's Education, Teaching Your Child To Be Financially Savvy and Don't Forget The Kids: Save For Their Education And Retirement.)

9. Flood Insurance

Unless you live in a flood plain or an area with a history of water problems, don't even bother buying flood insurance. If none of the homes in the area has ever been flooded, yours is unlikely to be the first.

10. Credit Card Insurance

Purchasing coverage to pay your credit card bill in the event you cannot pay it is a waste of money. A far better idea is to avoid running up your credit cards in the first place, so you won't need to worry about the bills. Not only do you not save on the insurance premiums, you'll also save the interest on your debt. (To learn more about credit, see Take Control Of Your Credit Cards, Credit, Debit And Charge: Sizing Up The Cards In Your Wallet and Understanding Credit Card Interest.)

11. Credit Card Loss Insurance

Federal law limits your liability if your credit card is stolen. Your out-of-pocket costs are limited to $50 per card and not a penny more. In fact, many credit card companies don't even try to collect the $50.

12. Mortgage Life Insurance

Mortgage life insurance pays off your house in the event of your death. Rather than add another policy - and another bill - to your list of insurance plans, it makes more sense to get a term-life policy instead. A good life insurance policy will provide enough money to pay off the mortgage and to cover other expenses as well. After all, the mortgage isn't the only bill your survivors will need to pay. (To read more, see Buying Life Insurance: Term Versus Permanent.)

13. Unemployment Insurance

This coverage makes minimum payments on your bills if you are out of work, which sounds like an attractive proposition. A better plan is to save your money and build up an emergency fund instead. You won't have to cover the cost of the insurance policy and, if you are never out of work, you won't spend any money at all. (Find out how to create an emergency fund in Build Yourself An Emergency Fund.)

14. Disease Insurance

Policies are available to cover cancer, heart disease and other maladies. Instead of trying to identify every possible disease that you may encounter, get a good medical coverage policy instead. This way, your medical bills will be covered regardless of the problem you face. (For related reading, see Fighting The High Costs Of Healthcare.)

15. Accidental-Death Insurance

Unless you are extraordinarily accident prone, an accident is unlikely. Major catastrophes such as car wrecks and fires are covered under other policies, as is any harm that comes to you while at work. Accidental-death policies are often fraught with stipulations that make them difficult to collect on, so skip the hassles and get life insurance instead.

When Choosing Insurance

There are so many policies to chose from, and they all cost money. While a certain amount of insurance coverage is necessary and prudent, you need to choose carefully. In general, broad policies that offer coverage for a multitude of potential events are a better choice than limited-scope policies that focus on specific diseases or potential incidents. Before you buy any policy, read it carefully to make sure that you understand the terms, coverage and costs. Don't sign on the dotted line until you are comfortable with the coverage and are sure that you need it.

Five Insurance Policies Everyone Should Have

Protecting your most important assets is an important step in creating a solid personal financial plan. The right insurance policies will go a long way toward helping you safeguard your earning power and your possessions. In this article, we'll show you five policies that you shouldn't do without. (To find out about some insurance basics, see Understand Your Insurance Contract.)

1. Long-Term Disability Insurance

The prospect of long-term disability is so frightening that some people simply choose to ignore it. While we all hope that, "Nothing will happen to me," relying on hope to protect your future earning power is simply not a good idea. Instead, choose a disability policy that provides enough coverage to enable you to continue your current lifestyle even if you can no longer continue working. (Protecting Your Income Source provides a closer look at this important topic.)

2. Life Insurance

Life insurance protects the people that are financially dependent on you. If your parents, spouse, children or other loved ones would face financial hardship if you died, life insurance should be high on your list of required insurance policies. Think about how much you earn each year (and the number of years you plan to remain employed) and purchase a policy that will replace that income in the event of your untimely demise. Factor in the cost of burial too, as the unexpected cost is a burden for many families. (For a more detailed look at the types of coverage available and factors involved in choosing the right coverage for your situation, read Buying Life Insurance: Term Versus Permanent and How Much Life Insurance Should You Carry?)

3. Health Insurance

The soaring cost of medical care is reason enough to make health insurance a necessity. Even a simple visit to the family doctor can result in a hefty bill. More serious injuries that result in a hospital stay can generate a bill that tops the price of a one-week stay at a luxury resort. Injuries that require surgery can quickly rack up five-figure costs. Although the ever-increasing cost of health insurance is a financial burden for just about everyone, the potential cost of not having coverage is much higher. (For more insight, see Fighting The High Costs Of Healthcare.)

4. Home Insurance

Replacing your home is an expensive proposition. Having the right home insurance can make the process less difficult. When shopping for a policy, look for one that covers replacement of the structure and contents in addition to the cost of living somewhere else while your home is repaired. (To keep reading on this subject, see Insurance Tips For Homeowners.)

Keep in mind that the cost of rebuilding doesn't need to include the cost of the land, since you already own it. Depending on the age of your home and the amenities that it contains, the cost to replace it could be more or less than the price you paid for it. To get an accurate estimate, find out how much local builders charge per square foot and multiply that number by the amount of space you will need to replace. Don't forget to factor in the cost of upgrades and special features. Also, be sure the policy provides adequate coverage for the cost of any liability for injuries that occur on your property.

5. Automobile Insurance

Some level of automobile liability insurance is required by law in most localities. Even if you are not required to have it and you are driving an old junker that has been paid off for years, automobile liability insurance is something you shouldn't skip. If you are involved in an accident and someone is injured or their property is damaged, you could be subject to a lawsuit that could cost you everything you own. Accidents happen quickly and the results are often tragic - having no automobile liability insurance or purchasing only the minimum required coverage saves you only a small amount of money and puts everything else that you own at risk. (To learn more, see Shopping For Car Insurance.)

*Bonus Tip For Business Owners: In addition to the policies listed above, business owners need business insurance. Liability coverage in a litigation-happy society could be the difference between a long and prosperous endeavor or a trip to bankruptcy court.

Shop Carefully

Insurance policies come in a wide variety of shapes and sizes and boast many different features, benefits and prices. Shop carefully, read the policies and talk to the salesperson to be certain that you understand the coverage and the cost. Make sure the policies that you purchase are adequate for your needs, and don't sign on the dotted line until you are happy with the purchase.