If all goes according to plan, most of your clients can look forward to a financially secure retirement -- thanks, in large part, to their participation in a qualified retirement plan. But what if they become disabled along the way? In that case, they'll need help to keep the future safe -- help that you can provide through individual disability income insurance.
Savvy financial advisors are beginning to make the connection between retirement and disability. They understand that building an adequate retirement fund requires one thing above all: It requires that an individual be able to work -- not only to maintain their current lifestyle, but to make contributions to a retirement plan and ensure continued employer contributions to the plan as well.
Savings suffer
Consider this simple example: A 45-year-old works until age 65 and makes 20 annual payments of $10,000 to a defined contribution plan. Assuming an annual investment return of 8 percent, the value of the retirement fund at age 65 will be $494,229.
But what happens if disability strikes? The impact can be dramatic. Assume that this same 45-year-old makes five annual payments of $10,000 to the plan, then becomes totally disabled at age 50. Assuming that the disability is permanent and no more contributions can be made, a huge gap appears at age 65. Instead of growing to $494,229, the retirement fund would be only $200,986. That's a gap of over $293,000 -- a serious one indeed.
Even a shorter disability can mean a dramatic loss of retirement plan value. If the same individual were disabled for two years, they would lose over $61,000 of value in the retirement fund. And if the disability were to last five years, the loss of value at age 65 would come to almost $137,000.
The insurance factor
A long-term disability (LTD) can spell disaster for your client's future. Traditional group and individual insurance plans can't help much. They are designed to replace only a portion of current income. They are not generally intended to replace lost employee or employer retirement plan contributions.
A few disability insurers have developed programs specifically designed to replace lost retirement savings. A few group LTD carriers now offer an optional benefit that makes payments to a disabled employee's 401(k) or pension plan, in addition to the regular monthly LTD benefit.
There is, however, another type of retirement protection program that you should consider, especially for your higher-income or self-employed clients. Currently available from only three insurers, it uses an individual disability income policy or rider to replace lost retirement plan contributions. Instead of directing disability payments to your client's pension plan, the policy pays benefits into a trust that is set up specifically for the policyholder's benefit. The trustee invests the policy benefits until your client, the trust beneficiary, reaches age 65. At that point, trust assets are distributed to your client to provide a retirement income.
One attractive feature of the trust approach is that the disability coverage is issued in addition to any other disability benefits an individual has in force. The amount of monthly benefit issued is dependent only upon the level of current employee-plus-employer retirement contributions. Policy issue amounts may go up to the federal maximum contribution limits for qualified plans. A future-increase option can be added to the policy to provide additional protection as your client's contributions increase.
Setting up the plan
Apart from the normal disability insurance application process, setting up a retirement protection program is quite easy. All that's required is your client's signature to authorize the establishment of the trust at the time of disability. Your client controls how trust assets will be invested in the event of disability. If they die before reaching 65, trust assets will be distributed to the estate or to a designated beneficiary. Since the program is funded by an individual disability policy, your client owns the policy, and it is therefore portable if they leave their current employer.
Generally, all types of defined contribution (DC) plans are eligible: money purchase plans, profit sharing plans, 401(k), 457 and 403(b) plans, simplified employee pensions (SEP) and SARSEPs (an SEP set up before 1997 that includes a salary reduction arrangement) employee stock ownership plans (ESOPs), IRAs, savings incentive match plan for employees (SIMPLEs), and Keogh plans. Nonqualified deferred compensation plans may also be eligible on a case-by-case basis. Defined benefit plans (DBs) do not fit well with the disability trust concept because they experience widely variable funding from year to year. Some small-business DB plans -- designed primarily for the benefit of one or two owners -- may, however, be considered.
Prospects for the retirement protection concept
Any individual who is planning for retirement and participating in a DC plan is a prospect for this arrangement. Start with your existing clients -- especially those who have already purchased qualified retirement plans, group LTD, or individual DI from you. Your life clients are likely to participate in retirement plans as well.
Professional groups, such as dentist or physician group practices, law offices, or CPAs offer especially good opportunities for the retirement protection sale, as either an employer-paid plan or voluntary employee program. Physicians tend to be particularly interested in retirement protection, as they are limited in the amount of normal disability income coverage they can obtain and are generally maxing out their pension plans. Employer-sponsored multilife plans may also qualify for guaranteed issue. This is an attractive approach, as medical underwriting would not be required.
Should you get involved in the retirement protection concept? Absolutely. Few advisors are addressing it with their upscale clients. And retirement protection offers everything you need to leverage a growing concern about the critical issue of retirement security. In addition, it provides terrific cross-selling opportunities with your existing clients.
John L. Newell, CLU, ChFC is the manager of training and professional development for Berkshire Life Insurance Company of America, Pittsfield, MA, a wholly owned stock subsidiary of The Guardian Life Insurance Company of America, New York, NY. He can be reached at john_newell@berkshirelife.com.
