Making the Decision Between Disability and Life Insurance

Most people tend to forget that in the event of disability, life insurance policies do not automatically extend benefits unless particular disability riders are added to the policy.  A insurer must take out a separate disability insurance policy. In fact, the probability of a 35 to  45 year old person being disabled is many times greater than that of death.  A few basic points can help understand the benefits that disability insurance and life insurance offers:

Benefits

Life insurance typically focuses on death benefits. It is meant to help your dependent family members cope with your loss, pay off your outstanding debts and taxes and even to leave behind charitable bequests after you pass away. Life insurance policies can also have some living benefits in terms of additions or riders that allow for payouts in the event of critical illness or terminal illness.

Disability insurance on the other hand focuses entirely on living benefits, Benefits from disability insurance are typically meant to help replace your lost income. For example, if you are sick and are unable to work, you may not be eligible for paid sick leave, but your mortgage payments and car payments still need to be made. Disability insurance makes up for this lost income up to the amount of your pre-disability take home income.

Beneficiaries

The death benefits of life insurance policies go to beneficiaries, which you designate in the policy. Typically, beneficiaries are spouses, parents and children.  For disability insurance, however, the policy benefits are typically paid directly to you as the beneficiary of the policy.

Non-forfeiture Benefits

Life insurance policies can have certain non-forfeiture benefits such as cash surrender value.  Life insurance policies can also be used as collateral and loans can be taken against the policy.  In contrast, disability insurance does not have any of these benefits. Disability insurance only pays out in the case of a true disability.

Waiting Periods & Duration of Benefits

With life insurance, a death benefit payout is made soon after death, and can be in the form of a lump sum payment.  The payment can also be received in the form of an annuity, over a period of time. Benefits are paid out only one time.

In the case of disability insurance, there is a prescribed waiting period that you must go through before disability payments can begin. This prevents frivolous claims and also ensures that the disability is serious enough to result in loss of income from employment. The duration of benefits depends on whether you have short-term disability insurance or long-term disability insurance. Short-term disability insurance has higher payouts, but as the term suggests, is meant to cover the short term – usually not lasting more than a few weeks. Employer disability insurance typically covers short-term disability benefits in conjunction with workers’ compensation payments. Long-term disability payments typically last up till age 65. It is possible to receive disability benefits multiple times over the course of a policy.

Taxes on Benefits

Generally speaking, life insurance death benefits are tax free to the beneficiary of the policy. A typical exception that may occur is when there is accrued interest on as a result of receiving the death benefits in the form of an annuity. The accrued interest portion of the payment received is typically taxable.

Disability insurance taxes are generally levied on disability benefits received by the beneficiary regardless of whether the payment comes from a private plan or a government plan such as Social Security. There is a possibility that if the policy owner is paying the premiums for private disability insurance with after tax money, the disability payments may be tax exempt.

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