If you’ve given serious thought to your
personal financial plan, you probably have considered how a long-term
disability could impact your financial security. Various studies put the
chances of an individual becoming disabled at some point during a working
career at anywhere from 30% to 50%. In fact, working adults are more likely to
become disabled than they are to die. 1
Perhaps you’ve heeded such statistics,
and are covered under a disability income plan at work. Perhaps you’ve even
supplemented that plan with an individual policy. Even if you’ve taken these
important steps, chances are that, in the event of a disability, these policies
may replace 60%-70% of your pre-disability earnings. This sum may cover your
living expenses, but is unlikely to be sufficient to allow you to save for
retirement or any other future need.
Furthermore, most disability income policies end payouts at age 65 or
your normal Social Security retirement age.
The importance of making regular
contributions to a retirement plan or IRA has grown in recent years. Gone are
the days of widespread coverage under a traditional pension plan, funded by an
employer and paying a guaranteed income for life. Though some individuals are
still covered under a traditional pension plan, one is more likely to
participate in a defined contribution plan, such as a profit sharing or 401(k)
plan. These plans typically rely heavily on employee contributions in order to
build up a sizable account balance.
Where will you find the income to
continue to make retirement plan contributions in the event of a disability?
Failing to make retirement plan contributions can have a dramatic impact on the
accumulated nestegg at retirement age. For example, an individual who, at age
40, begins to contribute $500 each month to a retirement plan will have built a
nestegg of almost $350,000 at age 65 (assuming a return of 6% and not taking
taxes or inflation into account). What if that individual becomes disabled at
age 55 and cannot afford to continue to make contributions for the remaining
ten years until retirement? Even if the plan balance remains untouched until
age 65, their retirement nestegg will be significantly smaller: only a little
more than $260,000. The difference is even more dramatic at higher contribution
levels. Even a year or two of missed contributions can reduce the nestegg,
especially if they occur early in one’s career.
Some disability insurance carriers have
developed products specifically designed to provide retirement plan
contributions. Known under various product names (depending on the carrier),
such retirement income protection plans are not pension plans: they are
disability policies that pay, as the benefit, an amount that approximates what
the disabled insured would have been contributing to a 401(k), profit-sharing,
or other type of retirement plan, had he or she been able to work. The goal
under such policies is to provide the insured with the retirement income that
would have been expected if the disability had not occurred.
The benefit typically is based on the
average contribution the insured had been making to a retirement plan, up to a
maximum as set by the policy (usually based on the retirement plan contribution
limits set by federal law). The benefit also may include an amount for any
contribution the employer normally would make. The benefit is deposited into a
trust product at a financial institution. Investment decisions are typically
made by the insured. At retirement age, the accumulated assets are distributed
to the insured to supplement whatever is received from their original
Policy specifics will vary carrier to
carrier. Riders may be available that adjust the benefit amount for inflation
or for income increases that would have been expected, if not for the
disability. As with any disability product, the prospective insured should pay
close attention to how disability is defined, for example, whether benefits eligibility
is determined by the inability to work in the insured’s regular occupation, or
The nestegg we build for retirement comes
as a result of hard work and discipline. It makes sense to protect that
nestegg, just as we protect other important assets, such as our lives and
homes. Retirement income protection recognizes the importance of saving for
retirement, and gives insureds the security of knowing they’ll be able to
continue to do so, even if faced with a disability.
Society of Actuaries 1985, CIDA Table.