Stay On Track
Unlike Defined Benefit pension plans, which allow workers to continue accruing retirement benefits during a period of disability, Defined Contribution (DC) plans such as 401(k) have no such mechanism. To retire on time, a special kind of disability benefit 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
Lack of awareness suggests that employees are unlikely to help themselves without special communication.
The Age of Individual Responsibility
The shift away from pension plans to 401(k) plans has introduced many types of risk for employees. One of the most overlooked risks is how a medical condition may interrupt retirement contributions.
While workers often hope to find a way to make ends meet with on 60% income replacement, they overlook that much of the other 40% is funding their retirement obligation, which is not so optional.
How Retirement Disability Protection Works
Retirement protection disability issue amounts generally match the amount actually contributed to a qualified retirement plan, including deferrals and matches, at the time coverage is acquired. These amounts vary individually. As contributions increase, issue amounts may also increase to keep pace. However, if contributions later decline, coverage does NOT decline, even though over-insurance may result. It works like a ratchet or high water mark that way.
Retirement protection disability benefits are paid to a non-qualified trust which invests for the beneficiary's retirement. The level of control in self-directing the investments vary from one program to the next. Benefits cannot be paid to a qualified retirement plan because the disabled 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.