Disability Insurance for Self-Employed People (Definitive Guide)

Disability insurance for self-employed people offers protection if someone becomes unable to work. Rather than rely on government programs, you can get benefits that make more sense for your standard of living and get them faster. 

The biggest misconception is what people think of as a disability. Since it’s not immediately apparent when someone has cancer or develops a back problem, we tend to think it’s much less common. But 1 in 4 people will qualify as disabled for at least 3 months during their working years. 

Quick Summary

Disability insurance covers both your income and your business functions if you become unable to work. There are different types of disability insurance a business owner will want to consider: individual, key person, and business overhead expense. 

Disability Insurance Definition

Disability insurance has a couple of key features to look for and make it easy to understand. The first is the definition of disability.

The definition of disability determines what qualifies as a disability. Because insurance companies base their definitions on occupation, they will ask, “can you do your current job, or can you do any job?” Naturally, if you can do any job and that means you don’t qualify for a claim. That, in turn, puts you both in a terrible position and makes the whole point of the policy worthless.

Features to Look for / Add to Your Policy 

The first feature is the definition of disability called modified own occupation or true own occupation. They mean slightly different things.

Definition of Disability

Modified occupation means that you qualify for a claim if you cannot do your current job and are not otherwise gainfully employed.

Let’s look at an example. Let’s say a freelance programmer can’t type because they’ve developed a wrist problem. Now they cannot do their job and will receive benefits as long as they decide not to get a different job, which doesn’t involve computer work.  

The difference between modified and true own occupation is that true own occupation will still pay benefits even if you get a different job.

So in our example, if you’re a freelance programmer, let’s suppose you can’t program anymore. Instead, you switch to a more sales and lead generation focused role where you don’t have to spend hours and hours in front of a computer typing, and you hire someone else to do that. You’re still working and running your business, but you’re also receiving your disability benefits.

A note of caution. Most people (and by most I mean 99% of people with true own occupation of the policy) who go on claim, don’t choose to find new, more manageable work. This tends to be slightly different for people who are self-employed or run businesses because you have to be more type A to make that work. But most disabilities are musculoskeletal issues or cancer, and it’s hard to keep working when you’re focusing on recovery from these.

Partial or Residual Disability

Partial disability means you get paid your benefits if you have to reduce your working hours or your income because of a disability. This is really important because cancer is one of the leading reasons people go on a disability claim. When someone is ramping up chemo treatments and feels awful, they’ll struggle to get half as much done as they were doing pretreatment. Plus, they still get a disability claim.

Short-term vs. Long-term Disability Insurance

Short-term and long-term disability insurance work exactly how they sound. Short-term covers brief periods usually anywhere from seven days to at most two years. Long-term covers a minimum of two years all the way up to retirement at age 67.

The crazy thing is that short-term disability will cost you almost as much as a long-term disability policy. Since self-employed people tend to have more of an emergency fund than traditionally employed people, you can use that to cover any short-term issues and focus on the long-term.

Is Disability Insurance Worth It?

It’s up to the individual whether it’s worth it or not. But when you are captaining your own ship, it’s wise to have some safety nets in place. Some employers will usually have short-term group disability policies as part of the benefits package. But self-employed, it’s up to you.

But when you are working long hours in the late nights and don’t feel well, your wrist hurts or whatever the case may be, speaking from personal experience, disability insurance is comforting. You know that whatever happens, there will always be money coming.

How Disability Insurance is Different for Self-Employed People

With traditional W-2 employment, all you have to send for financial qualifications is a pay stub for last year’s taxes. However, with self-employed people, disability insurance companies will want at least two years of tax returns. Some ask for three. The underwriters will more heavily scrutinize your income both for stability and to make sure they aren’t over-insuring you.

Most disability policies cover around 60% of your income. But when you’re self-employed and say you had a crazy good year last year and made less the next year. If you go on disability, your monthly benefits might be higher than your current income and leave little incentive to recover and go back to work. Although I would argue that the actuaries developing these policies probably never worked for themselves and don’t understand the drive.

Disability benefits are also part of the benefits packages you miss out on by being an employee. As self-employed people, we have to take care of everything ourselves, from health insurance to the home office.

Side note: the other significant benefit self-employed people have to handle themselves is their retirement planning. While a company-matched 401(k) may not be an option, self-employment opens up other lesser-known opportunities like using a life insurance policy designed to function as tax-free retirement income.

Cost of Disability Insurance

The three major factors in cost are your age, your biological sex, and your job. There isn’t much you can do about the first two. However, buying disability insurance sooner rather than later will mean that you pay less over time. 

A good agent, when asking about your job, will ask you about income and duties. The more you get paid, the better. The more executive-type duties you have, the better the occupation class you will get. A better occupation class means lower rates.

On average, a disability policy costs between 2% and 3% of your income. This varies based on the features you choose, as well as the underwriting factors above. 

Taxes

Many people ask if they can write off a disability insurance policy as a business expense. Personal disability insurance policies do not qualify. Business policies like key person or business overhead expense (covered below) do count as business expenses. 

Most people, even self-employed ones, pay for their personal disability policies with after-tax dollars. That makes any benefit tax-free. 

Underwriting Process 

When you fill out the application, there will be a few pages of questions. There may also be a phone interview. They will pull your medical records. You will have to do a paramed exam, which involves height, weight, blood sample, and a urinalysis. If you are in your 50s, they might also have you do an EKG.

Make sure you have at least two, if not three, years of tax returns that you can send the underwriters so they can determine your financial qualifications.

Business Overhead Expense

Business overhead expense insurance covers your business expenses for a 12 or 24-month benefit period – your choice. 

The biggest confusion with DI business overhead is the benefits structure. The benefit amount is not a monthly payout, like personal disability insurance. It’s a maximum limit for reimbursement. 

Yes, you need to submit your expenses every month to your disability insurance company while on claim. Then they send you the check for your qualifying expenses, up to the limit you choose on the contract. 

Business overhead covers everything from employee payroll to electricity. 

The benefit period is short compared to personal disability insurance because most people choose to sell their business if their disability looks like it may take years to recover from. 

Key Person Disability Insurance

Key person disability insurance is the other type of business disability insurance. It covers a person working for a business and pays the company if that person suffers a disability. For self-employed people, that’s usually you, the owner. However, it can also be any other person vital to your business. 

The theory behind key person is the insurance pays for finding a replacement employee on short notice. Specialized skills are challenging to find. This covers the cost of hiring either a temporary replacement or the search for a new long-term person. 

FAQ

Can I still qualify for state or federal disability?

To qualify, you will have to have paid in enough to Social Security that the government allows you benefits. This varies by your state. For federal disability, you can get the most up to date info on the SSA website. If you’ve been choosing to pay this when you do your quarterly taxes, then you might qualify, but you can also check on the IRS website.

Can I buy disability insurance on my own?

New tools come out every year to make purchasing insurance faster and easier. However, given the complications of buying insurance as someone self-employed, it would be smarter to go with an agent and will likely still save money.

Does disability insurance count as a business expense?

Personal disability insurance does not. However, business disability insurance, like business overhead expense or key person, does count as a business expense.

Can independent contractors get short-term disability?

Yes. You will have to purchase it on your own, but a few companies will let you buy a short-term policy. However, with the cost of short-term disability insurance, it would be wise to do a cost-benefit analysis on paying for disability insurance versus building up your emergency fund.

Conclusion

Protecting your business protects your family. Suppose you keep your business afloat through key person or business overhead expense disability coverage. In that case, you can still provide for your family. However, covering both bases is common for risk-averse business owners. 

How Abrams Insurance Solutions Can Help

At Abrams Insurance Solutions, we’re a small group of independent agents focused on helping our clients build solid financial foundations. That way, they can weather the bad years and know their loved ones will be okay. 

Disability insurance is one of those pillars of a robust financial safety net. 

You can complete the quote form on this page to receive quotes from leading disability insurance companies. Remember to use the tips listed above to get the best occupation class (lowest rates) possible. 

Give us a call at 858-703-6178 with any questions. We’re happy to help, and there is never any obligation to move forward.