WCI #6: Disability Insurance for High Income Earners

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli.

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What you do each day. Your work really matters. High income professionals are paid a high income for a reason and that's because their work requires lengthy years of training, high risk, and can really be very valuable to the people you serve. So thank you for what you do. You're probably on your way into work on your way home from work today, and I want you to have your head up and shoulders back when you think about the important work you do each day. Thank you to all of you for your feedback on the podcast. We've gotten lots of great constructive criticism, thankfully sent to our email rather than posted on itunes. We appreciate you sending all the good stuff to itunes and all the bad stuff to us so we can fix it. Today we're going to be talking about disability insurance, which is a pretty critical form of insurance for any high income professional. Unfortunately, it can be pretty complicated stuff. Unlike life insurance, which can be very simple. Disability insurance is fairly complicated and the reason for that is that life and death is black and white. I mean, I'm an emergency physician and I see all the shades of gray between life and death. It lasts about 15 minutes and then you're either dead or you're alive. It's very easy. Unfortunately, disability is like 50 shades of gray. It's complicated and so it requires a different approach and a much more complicated policy and unfortunately a lot more expertise and a lot more time spent understanding the product. Disability insurance is also different from life insurance in that it is sold in proportion to your income and so depending on how much of your income is lost, that's how much of your disability insurance benefit you'll be paid. It's also different from life insurance in that it is far more likely to be used. You have about a 1 out of 7 chance during your lifetime to use your disability insurance. And so that's part of the reason why it's so expensive is because doctors and other high income professionals use it all the time. So that's the main reason why you should have disability insurance is simply because your ability to earn money is your most valuable asset, especially if you're early in your career and it really needs to be protected. I mean, it would be a true financial catastrophe if you lost your ability to work at any time in your 30s or probably even 40s. However, not everybody needs disability insurance. Once you're financially independent, you don't need it. If you have another plan in case of disability, you may not need it. For example, some military physicians have a benefit through the military for disability. And if that's adequate to meet your needs, you don't need to buy a separate policy. In addition, many dual professional couples can rely on each other in the event of disability and don't feel like paying the expensive premiums in order for both partners to have it because they simply feel they can rely on the other if one of them gets disabled. So those are some situations in which you might not want to buy disability insurance, but the general rule is you need to buy this stuff when you're a resident and then when you become an attending and can afford it, buy some more. Unfortunately, when you go to buy disability insurance, you usually run into a little bit of sticker shock. This stuff's expensive. You typically will pay anywhere between 2% and and 6% of your benefit. That means if you're getting a benefit of $10,000 a month, that's going to cost you anywhere between 200 and $600 a month. It's not an insignificant expense. However, because it's so important, you still ought to look at it as something you just have to buy. Kind of like malpractice insurance. That way, however, you don't have to pay those premiums for your entire career. The faster you can get to financial independence, the faster you can cut back and not pay those disability insurance premiums. In fact, as you approach it, you may even be able to cut back a little bit on your benefit. Remember, the disability insurance companies, like a life insurance company, they don't have any problem with you cutting back on how much benefit you're purchasing. The only tricky part comes in when you're trying to buy more of a benefit. However, Keep in mind that with disability insurance, it only pays until you're 65 or 67. So as you get into your 60s, you're paying the same premium for less benefit. For example, if you get disabled at age 30, you are going to get benefits for potentially as long as 35 or 37 years. But if you get disabled at age 62, well, shoot, you may only get benefits for three years and that might not be worth paying all those premiums for to you. How much insurance to buy is a question that a lot of doctors have. And you know a disability insurance agent is going to try to get you to buy as much as possible. Oftentimes they'll use some sort of ratio with your income that you should replace a certain percentage of your income. But in reality, what you need to replace is your expenses. And so you need to look at your expenses. If your expenses are very low, you may not need that much disability insurance. And so that, that's really the key. But bear in mind that because your disability insurance will stop paying at age 65 to 67, that you need to be getting enough of a benefit that you can continue to save for retirement using that disability insurance benefit. Remember also that with disability insurance, the tax treatment on the benefits is the same as the tax treatment on the premiums. As a general rule, you buy disability insurance with post tax money. You pay your premiums with money that you've already earned and paid the taxes on. And the benefit of that is when it gets paid out, it comes out tax free. You don't have to pay any income tax or payroll tax on your disability insurance benefits. And so that also bear in mind you don't have to replace the amount of your income that's going to pay for your taxes. And the truth is, most disability insurance companies won't allow you to buy more than about 60 or 70% of your gross income in disability insurance benefit. They simply want you worth more, not disabled, than you are disabled. When you go to buy disability insurance, the key is the definition of disability. You want the strongest possible definition you can get. What you don't want is for you to have some sort of disability. And then you go to the company to get paid and find out that for whatever reason, that particular disability isn't covered. So you really want to pay attention to what the definition of disability is. Remember that disability is 50 shades of grey and you want all 50 shades covered. There are two main types of policies. There are individual policies and there are group policies. And they both have their pluses. And Their minuses. The benefit of an individual policy is it usually has a stronger definition of disability. And in addition it is portable, meaning if you change jobs, you can go to another job and take that disability insurance policy with you. A group policy is beneficial for a couple of other reasons. The first is that it's often cheaper than an individual disability policy. The reason for that is usually because the definition of disability isn't as strong and other provisions may not be quite as good. But another benefit of that group policy is that you don't have to qualify for it in the same way you do for an individual policy. They don't ask nearly as many pesky questions. They don't do nearly as extensive of a medical exam. And if you're having trouble getting disability insurance, a group policy is often the best way to go. But ideally you will get an own occupation specialty specific definition of disability. So if you're a surgeon and you can't do surgery, it's going to pay out. That's what you're looking for. There are a number of different waiting periods available, meaning how long you have to be disabled before it starts making giving you that monthly benefit. Typically you'll choose a 90 day period. And the reason for that is because you ought to have 90 days in your emergency fund that can be used to pay for your living expenses in that time period. But they'll also offer a 30 day period and 180 day period. And you may want to consider those as well. But in General, I think 90 days is probably ought to be the default. You want to buy these policies from an independent agent. And the reason for that is there are a. There are five companies that offer own occupation specialty specific disability insurance policies to physicians. So we call these the big five, the Standard Principal Guardian or Berkshire, Massmutual and Emeritas. And you want an agent who can sell you a policy from any one of those companies, because depending on your age and gender and health status and state specialty, one of those policies is probably going to be better than the other ones. And so the agent's purpose is to help you choose the right one and to explain to you the differences between the policies. So that agent is going to earn a pretty significant commission for selling you this policy. Don't be afraid to put them to work explaining the policy so you understand it completely. If you go to buy disability insurance and that agent is only showing you one policy that is not the person you want to buy from. So keep moving along until you can find a truly independent agent, a lot of People wonder why I don't put Northwestern Mutual into that big five. And the reason for that is that they don't use as strong of a definition of disability, although it's pretty difficult to tell until you really wander out into the weeds on these definitions. They use something called the medical occupation as their definition of disability, but in reality it's not really true own occupation. For example, if you were an orthopedic surgeon and 60% of your time was spent performing orthopedic surgery and 40% was spent doing office visits and other patient care, that under this medical occupation definition of total disability, since more than 50% of the surgeon's time was spent providing direct patients patient care and services, he can't perform the principal procedures of his procedure based board certifiable specialty, but can still do his other principal duties. The Northwestern Mutual's medical occupation definition would give him two choices. One, he can stop working and get the full benefit, or if he continues doing his work in the clinic, he would receive a benefit that's proportionate to how much income he's lost. So the issue with that medical occupation of disability is that it's dependent on how much income is lost rather than just your ability not to perform your specialty. So a stronger definition would pay you. A weaker definition would only pay you partially. The other reason I don't like putting Northwestern Mutual Insurance Company on that list is because of a lot of the ways in which their agents are trained to approach you. You're much more likely to have someone try to sell you a whole life insurance policy you don't need by a Northwestern Mutual agent than by a more independent disability insurance agent. Bear in mind that these policies often have exclusions and other things they don't cover, just like life insurance. If you have some risky hobbies, and it's interesting because they only include some risky hobbies, but the things they generally look at are climbing, scuba diving, flying and skydiving. If you do any of those, you're probably going to get an exclusion rider on your disability insurance. So when you go in to buy it, you may want to wait until you have no activities planned in the next three months of any of those risky hobbies and haven't done any of them in the last six months. And that should allow you to answer the questions honestly without telling them that you're a rock climber or a scuba diver, which is going to result in that activity not being covered if you are disabled. Other things that are often excluded include war, an active war, active military duty, normal Pregnancy, foreign travel, mental or nervous disorders. Although many policies will cover that, it's often only limited to two years and any medical conditions you have when you bought the policy. For example, if you have heart disease, when you buy the policy, they're going to exclude any disability caused by heart disease. And so it's best to buy this stuff before you get sick. There are a number of riders that are sold with these policies and some of those are more valuable than others. I recommend everybody purchase the residual or partial disability rider. This is the one that pays if you're only partially disabled and pays as you are returning to your full ability recovering from disability if you are young. I also recommend you buy the cost of living rider. And the reason for that is you have many decades worth of benefits if you become totally disabled. And inflation can do some nasty work on how much that benefit is really worth. So if you're buying it relatively early in your career, let's say the first half of your career, I recommend you get a cost of living rider as well. If you're buying this policy at 55 and it's only going to pay until you're 65, that's probably a rider you can skip. Another rider that is frequently offered is a future purchase option rider. And the problem with that rider is that if you're an attending, you've probably already bought as much disability insurance as you're ever going to need. I mean, the need for this stuff is highest earliest in your career when your net worth is the lowest. But if you're a resident or in some other way, expect your income to dramatically increase in the near future, you do want to use a future purchase option. That way you don't have to prove your insurability in a couple of years when you need to increase your benefit. Another rider frequently offered is called catastrophic coverage. And in that rider, when you are really disabled, for example, if you can't do two or more activities of daily living, they'll pay you an extra amount above and beyond your regular disability benefit. I think that one's probably worth skipping. I would use the money that you would spend on that rider and just buy a bigger benefit. Another coverage that's often offered these policies is a retirement coverage rider of some type. Basically, if you get disabled, it gives you some money to save toward retirement above and beyond the usual benefit. The problem with this rider is it usually dictates where that money goes and it's usually a high cost insurance based investing product. And so I'm not real excited about paying for that rider either. I suppose if they throw it in at no extra price, it's still the most competitive policy for you. That would be fine to have, but I wouldn't pay extra for that rider. I would just again use the money you would spend on the rider to buy a bigger benefit and then you can use that benefit to save for retirement in addition to, you know, your living expenses. All right, let's move on to a couple of questions I've gotten recently about disability insurance. One reader writes in and says I a bunch of disability salespeople have told me it's cheaper for me to buy a policy while I'm in residency or fellowship than when I get out of training. Is this true or is it only true? Because presumably I would be buying a lower amount in training than when I'm in attending, assuming no change in health status. When I go from training to attending status and purchasing the same amount of coverage, is it cheaper or more economical to make the purchase earlier? Well, in this case it is cheaper to buy a policy earlier, and the reason why is you're younger and healthier. It's always going to be cheaper to buy a policy at 28 than it is to buy a policy at 30 or 35. And so yes, you should buy it as early as possible because the premiums are cheaper. But more importantly, you need to benefit even more when you're younger because your net worth is even lower. And so I do recommend you buy it earlier. Probably as soon as you get into residency is the time to buy a policy. Now you're going to have to buy a future purchase option because you won't be able to afford as much disability insurance as you need as a resident, but you should get it as a resident. Another reason it may be a little bit cheaper as a resident is because oftentimes you are put in a different specialty category as a resident than you are as an attending, even in the same field. And so that's one reason why in some fields when you move from being a resident to being an attending, even though you're only a day older, it will actually cost you more for the same benefit. Alright, Another question comes from PGY1 in orthopedic surgery. He's married with two kids, has a wife who stays at home with the kids and makes supplementary income as a photographer. They break even month to month while saving the maximum matched amount through the institution and have a debt on their house of 154,000 and 143,000 in student debt. Those are actually pretty good numbers, I think he writes. My question is, do you think it is financially wise to take out a loan simply to pay for an increased level of life and disability insurance throughout residency? Now, basically, this is someone who's realizing his need for insurance is more than he can afford. As a resident, your need is just as high as a resident as it is as an attending, yet you won't be able to afford as much because disability insurance is expensive. So he's wondering, should you borrow in order to get more of a benefit? I think probably not. I think there's some risk there for sure. But you can always buy more insurance and when you're getting to the point where you're borrowing to buy it, I think you're probably buying too much. So I would not borrow money to buy more disability or life insurance. However, if you find that you're just spending your entire income and can't buy any disability or life insurance at all, I I think you probably need to take a look at your spending and maybe get on a stricter budget and carve out a little bit of money to buy these important forms of insurance. This stuff isn't that expensive to buy the typical amounts that people buy during residency.

The White Coat Investor is proud to introduce our no Hype Real Estate Investing course which will provide the framework for developing further knowledge and experience as you progress in your real estate investing career. We call it an introductory course because there's always more to learn. But this is no short, superficial course. There are over 200 lectures and videos adding up to more than 2027 hours of content by over 15 different instructors. We think it just might be the best real estate course on the planet. Continue your wealth building journey today with the no Hype Real Estate Investing course@whitecoatinvestor.com courses. You can do this and the White Coat Investor can help.

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