This is a question that is not easily answered. In fact, it’s usually answered by asking a series of other questions. Here are five of the most important of those questions.
1. How Risky is Your Occupation?
This question attempts to determine how likely you are to become disabled, and you need to file a claim for benefits. Some occupations are much more hazardous than others. It may also be that you are working in an occupation that is more likely to render you to be disabled on a permanent basis.
If that’s the case, then you will want to create a more generous disability benefits, since there is more than a slight chance that the policy will need to provide you with an income for the rest of your working life.
In addition, since more hazardous occupations are likely to result in total disability, you’ll have to take this into account. At the opposite end of the spectrum, less hazardous occupations could result in the types of injuries that would still allow you to continue working at least in a reduced capacity. You’ll have to adjust your expected disability benefit based on the risk either outcome.
2. What Other Income Sources Do You Have?
It’s seldom a matter of needing “X” amount of income from a disability policy, but more likely what your total income will be in the event that your earned income were to stop completely. You will want to consider any other income sources that you may have that will not be affected by your disability.
Some possibilities include early pension income, passive income sources (like rents on investment property), investment income, and passive interests in active businesses. Each of these income sources will reduce the size of the disability benefit that you will need.
Make list of any such income sources that you have that you will likely receive even if you have become totally disabled.
3. What Other Savings and Investments Do You Have?
This actually has more to do with temporary disability than it does with permanent disability. But if you have substantial savings and investments, you’ll have less need for a large monthly disability benefit.
Tally up all of your savings and investments – checking accounts, savings accounts, certificates of deposit, money market funds, investment brokerage accounts, individual stocks, bonds, and mutual funds, trust funds, and retirement funds.
If the total is high enough that you could live on your investments for the rest of your life even if you couldn’t work anymore, you can keep a relatively small disability benefit – or maybe even none at all.
Alternatively, if your savings aren’t enough to cover the rest of your life, but they could easily cover a couple of years and then some, you might still be able to take a lower monthly benefit under the disability plan.
4. What is the Minimum Amount of Income You Need to Survive?
Before you begin calculating how much money you will need from disability benefits, you should first calculate what the minimum amount of income that you must have just to survive.
This should include your recurring monthly expenses, such as your house payment, child support or alimony, child care, car payments, other debt payments, food, utilities, maintenance and repairs, and any recurring insurance premiums.
This will give you your target number for disability benefits. You can include optional expenses, such as entertainment, vacations, hobbies, and club memberships, but you should be aware that certain types of disability may limit your ability to participate in any of these activities. As well, the increased need for income will also cause the premium under the disability policy to be higher than it will if the policy were designed specifically to cover only necessary expenses.
5. How Much Can You Afford to Pay for Disability Insurance?
No matter what your income needs are, or what other income sources or assets you may have, ultimately the amount of disability insurance that you need will be limited by your ability to pay for it.
If you don’t have disability insurance, you’ll have to carve out some space in your budget in order to cover this very necessary insurance. But naturally, you never want to put yourself into a compromised financial situation in order to afford something, even something very important.
Consider items 1 through 4 above, then determine how much money you have left to pay for the coverage that you want. You may have to make some compromises, such as cutting out certain expenses so that you can afford the monthly premium for more disability coverage, as well as reducing the amount of a policy benefit.
You must always be certain that the premium you’re paying for your disability insurance will be sufficiently comfortable that you can afford it over the long term. Having a policy that you can barely afford – and dropping it after two years – could be a complete waste of money.
