Final answer:
Typically, disability insurance should replace around 60% to 70% of your before-tax income, accounting for tax-free benefits, but this can vary based on individual needs and existing healthcare costs.
Step-by-step explanation:
When considering the purchase of disability insurance coverage, a typical recommendation is to aim for a policy that can replace around 60% to 70% of your before-tax income. This takes into account that disability benefits are often tax-free, which allows a lower percentage of income replacement to still maintain a similar level of take-home pay. However, insurees must assess their own needs, considering factors like existing savings, expenses, and other sources of household income.
For people facing higher healthcare costs, representing at least 10% of their income, or for low-income adults whose medical expenses or deductibles are at least 5% of income, the level of income replacement might need to be adjusted upward to ensure they are not underinsured, especially since Social Security will only cover a portion of income in retirement.
Further, it's crucial to understand the fine prints of any policy, like how preexisting conditions are handled or the definitions of disability used, to ensure adequate financial protection and manage any related poverty traps, such as the loss of Medicaid due to an increase in income. Reflecting on these considerations can aid Luke in making an informed decision on his disability insurance purchase.