Stay On Track
401(k) and other Defined Contribution (DC) plans are not allowed to take contributions when a person is no longer actively at work. In order to correct for the interruption in contributions during a period of disability, a special kind of disability insurance - over and above group LTD - is required.
An Underestimated Risk
Council for Disability Awareness; The Disability Divide: A Consumer Disability Awareness Study; 2010; "How likely are you to be disabled for longer than 90 days before you retire?" See also, Milliman Inc; The Real Risk of Disability in the United States; on behalf of the LIFE Foundation; 2007
The Age of Individual Responsibility
The shift away from pension plans to 401(k) plans has transferred not only investment risk to employees, but disability risk too. One of the most overlooked risks is how a medical condition may interrupt retirement contributions.
How Retirement Disability Protection Works
Retirement protection disability benefit amounts work like a ratchet in that they can go up, but not down. They are determined at the time the policy is issued, as a fixed monthly amount normally payable until age 65. As 401(k) contributions fluctuate in the future, the issue amount remains the same unless an increase option is exercised. If contributions decline, coverage does NOT decline, even though over-insurance may result.
Retirement protection disability benefits are paid to a non-qualified trust - not the 401(k) - because, by law, benefits cannot be paid to a defined contribution qualified retirement plan when a worker has no earned income.
Retirement protection programs do not claim to be retirement plans or to provide perfect replacement. Rather, they are designed to mitigate a gap.
Age: 35, later disabled at age 40
401(k) Contributions: $875 per month
Account Values at Retirement (age 65)
Disabled at Age 40 Without Retirement Protection
No further contributions will be made after the fifth year due to disability. With an 8% return assumption, the Future Value at age 65 would be $421,861.
Disabled With Retirement Protection
If disabled and not working beginning at age 40 for the remainder of his career, the assets from the previous five (5) years have a Future Value at age 65 of $421,861. Adding disability retirement benefits beginning at month 6, with a 6% return assumption on that portion, the Future Value at age 65 would be $976,682.
Normal Age Retirement
This scenario assumes the works is never disabled at any point.
Beginning at age 35 with monthly 401(k) contributions of $875 and an 8% return assumption, the Future Value would be $1,189,464.
Would Retirement Protection require a change in the group's Long Term Disability (LTD) policy?
No, Group LTD is generally left untouched when implementing retirement protection. Retirement protection is provided by individual policies in order to accommodate wide variations in contribution levels between individuals and to avoid offsets. This also allows LTD carriers to be freely changed in the future without complication.
Frequently Asked Questions
about disability retirement protection benefits
Who are benefits paid to?
A non-qualified trust managed by the insurer, for the benefit of the insured. By law, funds cannot go into a qualified trust when a person is not actively at work. The trust is established upon the first benefit payment. Some insurers charge a nominal trust fee.
What are the investment options?
Any marketable security or mutual fund.
When can the Insured access trust assets?
Upon turning age 65, except for financial hardship or death.
The financial hardship exception can be triggered by extraordinary medical expenses of the insured, their spouse or dependents and not covered by insurance; or a need to stave off eviction from a principal residence or from the foreclosure on a mortgage for a principal residence.
In the event of death, funds will go to the named beneficiaries regardless of the insured’s age at the time of death. If no beneficiaries are named, funds will go to the estate.
What if the Insured suffers a disability and becomes incapacitated?
The Trustee will follow the instructions of the insured’s designated representative in the estate plans. If the insured has not designated anyone, the Trustee will follow instructions from the court appointed representative.
The Insured turns age 65. Now what?
The insured would have several options available to them with respect to trust assets:
Take a lump sum distribution
Set up periodic payments to fit their budget
Defer payment to a later date