New Protection for Old Danger

Cracked Egg HealingI have not written on the topic of disability lately, but there may be a new way to protect against its long term financial ravages. As of January 1, 2015, Treasury and the IRS have published final regulations (79 FR 26838) allowing a defined contribution retirement plan (think 401k) to replace contributions lost because an employee becomes disabled.

What did I say? Assume you are a 35 year old white collar worker. You are making good money, but contributing only enough to your 401k account to get the company match. You have $20,000 in your account now. You know you should get a little more serious about saving. You really don’t want to have to work another 35 years.

But what if you become disabled for 90 days or more? According to a 2010 Consumer Disability Awareness study, 64 percent of workers believe they have only a 2 percent chance of this happening during their entire career. The true likelihood is 24 percent for women and 21 percent for men at age 35, but only if they are not overweight and don’t use tobacco. Add tobacco and about 25 percent to your weight?  The statistics rise to 41 percent for ladies and 45 percent for the men.

Would 3 months off sink your ship? The same study says 38 percent of employees could not pay their bills for 3 months and 65 percent could not make it for a year if their income were lost.

If you are out for 90 days, there is a 38 percent chance the disability will last 5 years or longer for that now healthy person. The average of all group Long Term Disability (LTD) claims lasts 34.6 months. One in eight employees will be disabled for at least 5 years during his or her working career. Your hoped-for financial plan just flew out the window.

The old style defined benefit pension plans often carried a benefit for a disabled worker who could not return to work for some period or forever, but this capability had never been extended to the type of retirement plan that most workers have today. This is not a fear keeping any healthy employees awake at night, but it probably should be. Here is the action plan.

First, learn what group LTD protection you already have. At many large companies, it will cover about 50 percent of your regular income up to some limit (without bonuses or overtime). If your company pays the premium, any benefit will still be taxable income. If you can, pay any contribution you make from after tax income.

Second, buy your own individual non-cancelable policy from a high quality insurance company, even as an add-on. It will seem expensive. That’s because you are so likely to use it. Good quality is never cheap. You will only be able to cover 65 or 70 percent (in total) of your gross income, but any benefits received on this part will not be taxed. You can keep this protection wherever you go. Your chances of being at the same company 20 years from now are slim.

Third, if you are the one in eight who becomes disabled, you will most likely go from saving something to saving nothing for the time you are off work and while you recover financially. So this new capability for your company retirement plan is important. Tell your HR people you want some protection when it becomes available. It would be well worth it to pay 1 percent off of your gross investment returns to have the contributions continue even if you cannot. If you own your own business, tell your plan consultant you are interested in this.

The insurance industry tries to inform you of the importance of guaranteeing your future income. Most people suffer from the syndrome of It can’t happen to me! That is, until you get your cancer diagnosis or your spine is ruined. Don’t wait. Protect yourself from the biggest risk to your financial health.

(Past performance is no guarantee of future results. Advice is intended to be general in nature. Study can be found at www.disabilitycanhappen.org/research/consumer.)