Disability insurance for the FIRE community

In the first post of this series I talked about using the RETIRE framework to analyze your financial position. As a quick refresher, RETIRE stands for

  • Risk management/assessment
  • Expenses/income
  • Tax planning
  • Investments
  • Retirement planning
  • Estate planning

Most of the financial advice out there is designed for the average person – you know, the person who works until they are 67 years old, buys new cars every 5 years, and considers themselves frugal if they save 5% of their income each year.

Unfortunately, financial advice for the average person isn’t too useful for for the FIRE (Financially Independent/Retiring Early) community. We have unique needs – a much shorter length of time in the workforce, a much longer length of time in retirement, a very different mix of income sources, and different financial protection needs.

Today’s post will focus on the specific disability insurance needs for the FIRE community.

Does the average person seeking FIRE need disability insurance? To answer that we first need to look at some bloggers in the FIRE community.

A sampling of FIRE bloggers

Here are some of my favorite bloggers and what their careers are/were. These people have either already reached early retirement/financial independence or are on their way:

See a trend there?

The first two (Mr. Money Mustache and Financial Samurai) are already retired. They worked in highly lucrative fields. They had high incomes and saved/invested their money wisely.

Gen Y Finance Guy, unsurprisingly, works in finance. From what I can tell from reading his blog he and his wife made about $375k last year. That qualifies as highly paid by just about anybody’s definition. They are saving roughly 50% of that income and they have a goal of $10M in net worth in ~15 years.

The Conservative Income Investor has been attending law school. I believe he’s recently graduated and has stopped blogging to focus more time on his law career. It’s likely that he’s now a high earner and will be saving and investing aggressively.

Jason Fieber (AKA Mr. Free @ 33) is a notable exception to the trend. He worked in the service department of an auto dealership and I believe he’s said he never made more than around $60k/year. He was able to retire by keeping his expenses very, very low.

Not only are 4 of the careers much higher paying than the average career, but all of these jobs are “white collar” jobs. They involve sitting at a desk all day writing code, or meeting with clients, or doing other non-physical labor.

What the hell does this have to do with disability insurance?

Your chances of becoming disabled depends on your career

Here’s a stat that tends to get thrown around a lot – the average person is significantly more likely to become disabled than die during their working career. This is both true and misleading. Why?  Because your chance of becoming disabled is highly correlated with the type of job you have.

Probability of disability

Occupational class% chance of being disabled - men% chance of being disabled - women
Professional18.0%26.2%
Skilled33.3%38.2
Nonhazadous or light manual labor46.148.9
Hazardous or heavy manual labor49.252.3
Probability of a disability lasting longer than 90 days prior to age 65

The reality is that the people who are most likely to become disabled work in physically active jobs. They are mechanics, plumbers, etc. These are blue collar jobs that carry inherently higher risk than white collar jobs.

A person working to achieve FIRE is probably not working one of those jobs.

Why?

Because most people who are pursuing FIRE are either professional or skilled workers, simply by virtue of the fact that it’s hard to retire early on the low salary generated by more physical, blue-collar jobs.

The cost of disability insurance

Bringing this back around to disability insurance for the FIRE community – if you’re pursuing early retirement you’re probably working in a professional or skilled job where your chances of being disabled are much lower than average. However, even the lowest probability of being disabled is still 18% for men and 26.2% for women in professional careers.

That’s shockingly high.

So if you have a high chance of becoming disabled you should probably get insurance, right?

Well, first, we have to look a bit deeper at the odds of being disabled.  Those numbers in the table above are the cumulative chance of becoming disabled over the course of your career. The average person’s a career is approximately 45 years long (21 to 66). By definition, early retirement seekers are working for fewer years.

This means that the average person seeming FIRE has a lower total chance of being disabled than represented in the table above because:

  • They work fewer years
  • The years they are cutting are the later years (i.e. if you retire at 45 you’re not working from 45-65). These are the years where your body is less resilient and you’re more likely to become disabled.

As for the cost – because the chances of being disabled are so high, disability insurance is expensive. How expensive? It typically costs 1-3% of your salary per year.

The irony is that disability insurance is expensive enough that purchasing it will slow down your quest to FIRE.

Short-term disability insurance

Disability insurance comes in two categories: long-term and short-term insurance.

Short-term insurance provides income for the first 90-180 days that you become disabled and is intended as a bridge to long-term insurance.

Long-term disability insurance  usually doesn’t start paying benefits until you’ve been disabled for 90-180 days (this is called the “elimination period”), but it then pays until retirement age (typically defined as somewhere between 62 and 67 years old). The idea is that long-term disability insurance will replace the income you would have earned until you qualify for Social Security benefits at “retirement age”.

I don’t see any reason for somebody seeing FIRE to purchase short-term disability. It would be cheaper to just maintain enough of an emergency fund to cover the time period until your long-term insurance would kick in.

Social Security

Some people will point out that Social Security already provides disability insurance. That’s true, but Social Security’s definition of disability is incredibly strict. In order to be considered disabled (and be able to receive disability benefits) you have to be totally disabled. That is, you must be unable to do ANY productive work. Here’s the Social Security checklist – as you can see, they will dig into every aspect of your life, talk to your doctors, and review past work history to see if there’s any reason you wouldn’t be classified as totally disabled.

Are you able to stand and say hello to people? Then you could work as a greeter at Wal-Mart and you’re not disabled. You say you’re not able to stand, but you can sit? Well then, you could work at a call center and you’re not disabled.

The bottom line – don’t expect to collect Social Security disability insurance. It’s almost impossible to qualify for.

Own occupation vs. modified own occupation

The most common types of disability insurance are “own occupation” and “modified own occupation”:

  • Own occupation insurance means that you qualify as disabled if, solely due to injury or sickness, you are unable to perform the material and substantial duties of your own occupation.
  • Modified own occupation insurance means that because of injury or sickness, you are unable to perform the material and substantial duties of your own occupation, and are not engaged in any other occupation. If you DO go to work in another occupation your benefits would be modified appropriately.

Due to unfavorable claims experience, most insurers have stopped offering “own occupation” policies and only offer “modified own occupation” policies today.

Note that both types of policies are very different from the Social Security definition of disabled, which requires you to be unable to do any productive work.

Let’s look at an example so we can compare the types of insurance (own occupation, modified own occupations and Social Security disability) – you’re a surgeon and you lose a hand in a hunting accident.  You’ve trained to be a surgeon, your experience is in performing surgery, and now you are no longer able to perform surgery. By an “own occupation” definition of disability insurance you would be disabled and you would collect full benefits.

However, you might still be able to teach at a medical school or work as an advisor to a medical firm. If so, a modified own occupation policy would reduce your disability insurance benefits by the amount of income you’d receive from other sources.

By the Social Security definition you would NOT be disabled. If you’re able to teach or work as an advisor (even if you don’t want to do those things) then you’re not considered disabled and you’d receive no benefits.

Disability insurance through work

There is one good piece of news though – if you are indeed working in a white collar/professional job you probably already have disability insurance provided through your employer. And, unlike any term-life insurance provided through your employer, the disability insurance you’re provided is probably actually quite good.

Most disability policies replace a predetermined percentage of your income. If you receive bonuses or commissions it is important to check if they are included in the definition of income or not.

For example, my employer provides both short-term and long-term disability insurance. The long-term policy is a modified own occupation policy and pays 60% of my total income (base salary plus commissions, salary, etc). up to a maximum salary of around $200k. This means that even if my salary is over $200k, the maximum payout would be 60% of $200k/year, or $120k/year. Obviously that’s a pretty solid income replacement.

Taxes

One caveat about taxes on insurance benefits – while life insurance benefits are virtually always tax-free, the taxability of disability payments depends on how the premiums were paid.

If your employer pays your disability premiums as part of a benefit package to you then any eventual benefits would be taxable income to you.

If you pay your own disability premiums with pre-tax money (usually paid as part of a benefits package through your employer) then any eventual benefits would be taxable to you.

If you pay your own disability premiums with after tax money then any eventual benefits would be tax-free.

Conclusion

As I pointed out before, if you’re interested in early retirement or financial independence you are most likely working in some sort of white collar or professional job. You’re in finance, accounting, technology, business, law, health care, or another similar occupation. You’re well paid and you have good benefits through work.

This means your chances of being disabled are low. But more importantly, your chances of being totally disabled are tiny. If you’re a computer programmer you can still write code even if you can’t talk, walk, or hear. Even if you were to be unable to do your primary job you could still write/teach/consult to make money. Yes, you would likely make less money than at your chosen profession, but you wouldn’t be destitute.

Even if you feel that you do need disability insurance, you likely have coverage through your job anyway. Of course, this means you’d lose your insurance if you were to stop working, but then again, you’d stop working once you’d built enough net worth to cover your lifestyle (or become disabled, in which case the disability insurance would pay you).

Finally, if you’re seeking early retirement or financial independence it’s likely that you’re saving a significant portion of your income, which means the lower wage replacement ratio of disability insurance isn’t an issue. Fore example – let say you’re saving 40% of your income today. That money is being invested to help you get to early retirement. If you’re saving 40% of your income then that implies that you’re living on 60% of your income. And, coincidently, that’s the standard wage replacement ratio for most disability insurance policies. So the payout from your policy would allow you to live just like you are today, and since your disability payment will last until you retire, you no longer need to save and invest for early retirement.

This means there’s no need for any additional disability insurance to cover the “gap” between 60% wage replacement ratio and 100%.

Bottom line – disability insurance is something that most people reading this blog don’t need. You’re better off using that insurance/risk management money for something more valuable, like life insurance or an umbrella policy.

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