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
An Individual Responsibility
In the old days, pension accruals would continue during a period of disability. The trend away from pension plans to 401(k) plans has transferred disability risk to individual participants, meaning individuals have lost something in the transition.
The exposure is significant because unlike organizations that are under an obligation to provide a promise, individuals have the choice to look the other way.
How Retirement Disability Protection Works
Retirement protection disability benefit amounts are provided through individual disability insurance policies in order to avoid offsets with group LTD and accommodate variable contribution levels between individuals, among other reasons.
Usually these programs are employer sponsored, although standalone individual coverage is available as well.
Benefits are determined at the time the policy is issued as a fixed dollar monthly amount (for example, $2,000 per month) normally payable until age 65. As 401(k) contributions fluctuate in the future, the issue amount will either remain static or increase, but will not decrease.
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 as a partial solution to avoid total derailment of retirement.
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 individual 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 insured through individual policies in order to
(1) accommodate variations in contribution levels between individuals
(2) avoid offsets
(3) provide continuous coverage regardless of actively at work status
(4) allow LTD carriers to be freely changed in the future without complication
Frequently Asked Questions
about disability retirement protection benefits
When do retirement disability benefits begin and end?
Typically from day 180 until age 65 (or upon returning to work if sooner). Retirement protection coverage is offered as a rider with different attributes than the base policy to which it is attached. While a typical base policy will begin paying normal benefits after ninety (90) days, the retirement protection rider itself won't start until 180 days. Furthermore, retirement protection benefits will terminate upon returning to work, which is not necessarily so for other benefits payable from the very same policy.
Who are benefits paid to?
A non-qualified trust managed by the insurer, for the benefit of the insured. The trust is established by the insurer upon the first benefit payment with no need for the insured person engage legal counsel. 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.
Financial hardship may be due to 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
Regardless of whether benefits were paid, the rider falls off the policy at the policy anniversary after turning age 65 and the premium associated with the rider is no longer due (it is possible to drop the rider earlier upon request). Although a person may continue the base policy after age 65, there is no way to continue the retirement protection rider. The temporary nature of retirement protection riders reduces the insurer's risk, and the cost reflects that.