Handbook / Business insurance

Disability insurance for the self-employed: protecting your income

For most self-employed people, their ability to work is their biggest financial asset. Employees often have sick pay and group disability plans; self-employed people usually have neither. If illness or injury stops you working for months, your business income can stop with it. Disability insurance is designed for exactly that risk.

What disability insurance does

An individual disability insurance policy pays a monthly benefit if you cannot work because of illness or injury, as defined in the policy. Benefits replace part of your income so you can cover living costs and, with some policies, business overheads.

It is different from health insurance, which pays for medical care. HealthCare.gov covers health coverage options for the self-employed; disability insurance covers lost income.

Key policy features

Definition of disability

• Own-occupation: pays if you cannot perform the main duties of your own occupation.
• Any-occupation: pays only if you cannot work in any job suited to your education and experience.
• Hybrid definitions: own-occupation for an initial period, then any-occupation.

Own-occupation cover costs more but is more valuable for specialised work.

Waiting period

The time between becoming disabled and receiving benefits. Longer waiting periods reduce premiums; choose one your savings can cover.

Benefit period

How long benefits can last: a set number of years or until a specified age. Longer periods cost more but protect against long-term disability.

Benefit amount

Insurers usually limit benefits to a portion of your documented income. Higher benefits require proof of higher earnings.

Partial or residual disability

Pays a partial benefit if you can work but earn less because of a disability. Valuable for self-employed people who might keep working reduced hours.

Other options

• cost-of-living adjustments
• guaranteed renewable or non-cancellable terms
• future increase options as income grows

Proving self-employed income

Insurers typically ask for tax returns, often for two years, and may ask for profit and loss statements. Because benefits are based on net business income, aggressive expense claims can reduce the cover you qualify for. Clean books, as described in the guide to the profit and loss statement, make underwriting smoother.

Business overhead expense cover

A separate type of policy can pay ongoing business costs, such as rent, staff and software, while you are disabled, so the business survives until you return. It suits owners with significant fixed costs.

Tax treatment

The IRS explains that if you pay the entire cost of a health or accident insurance plan on an after-tax basis, you do not include amounts received for disability as income. If an employer paid the premiums, benefits are generally taxable. Self-employed people buying individual cover typically pay premiums personally, so benefits are often received tax-free. Confirm with a tax professional for your situation.

Employees and state programs

The SBA notes that some states require businesses with employees to have disability insurance, along with workers' compensation and unemployment insurance. If you hire, check your state's rules. Some states also run temporary disability programs.

Costs

Premiums depend on age, health, occupation, benefit amount, waiting period, benefit period and features. Get quotes from several insurers or an independent broker. Professional associations sometimes offer group plans to members, which may be cheaper but less flexible.

Fitting it into your budget

Disability cover is a real cost. Build it into your prices along with other benefits you replace as a self-employed person; the guide to setting an hourly rate includes these costs. The working-alone overview of business insurance types puts it alongside other cover.

Before you apply

Gather proof of income, such as recent tax returns, and a description of your daily duties. Compare several quotes with the same waiting period and benefit period so you are comparing like with like.

Review your cover

Check your policy when your income changes significantly, when you change occupation, or when you add dependants. A benefit set years ago may no longer match what you need to cover your household and business costs.

If your income depends on your ability to work, compare individual disability policies on definition, waiting and benefit periods and amounts, document your income cleanly, and budget for the premium.