As the defined benefit era yields to the trend toward defined contributions, more Americans are taking retirement planning into their own hands. Young people, especially, aren't counting on an old-fashioned pension or Social Security to see them through their golden years. Indeed, workers between the ages of 25 and 44 are more likely than ever to say they're saving for retirement, according to the Washington, D.C.-based Employee Benefit Research Institute.
But even with all the current emphasis on retirement savings, an important -- but rarely considered -- question arises: What happens if the paycheck-dependent Section 401(k) plan saver becomes injured or too ill to work? How will it affect his or her ability to secure a comfortable retirement and achieve estate-planning goals?
Even if this disabled individual has adequate disability coverage (whereby an insurance company would replace about 60% of income), in all likelihood retirement plan contributions would cease. By law, employees aren't allowed to contribute to the company plan when they're no longer on payroll. Few would have enough money to continue investing anyway, even in another qualified retirement plan such as an IRA or Roth IRA.
Considering that the U.S. savings rate hit negative territory in 2005 -- the lowest it's been since the Great Depression -- living paycheck-to-paycheck and spending more than we earn has become a way of life for many Americans, even those in upper income ranges. Needless to say, these people would need every penny of disability income insurance payments to scrape by with normal living expenses, let alone retirement savings.
An Unmet Need
Only a few companies offer insurance that protects retirement contributions in the event of disability. Since this type of protection is still relatively new, many agents are not even aware of its existence. But the importance of this retirement-focused disability income insurance offering to your clients and prospects is enormous. Some 48% of Americans say they'd probably have to stop making contributions to their retirement account in the event of disability, according to a recent survey by Guardian Life.
Anyone who contributes to a qualified retirement plan -- a 401(k), 403(b), SEP, IRA, Roth or other plan -- needs retirement contribution protection so that he or she doesn't have to rob other financial assets to fund the retirement plan when disability strikes.
It's truly eye-opening to consider the long-term impact of money diverted out of retirement savings. Most people don't run the numbers on these lost opportunity costs. But consider this scenario: Your client Robert, age 35, earns $100,000 per year. Robert contributes 10% of his salary to his 401(k), and his employer matches 3%. If he works for 30 years and has annual raises of 3%, Robert will contribute more than $650,000 toward retirement. Assuming an 8% return on his investments, Robert's 401(k) account would grow to $2,377,704 by age 65.
Now suppose Robert is disabled for one year at age 50, during which time no additional contributions are made to his retirement plan. When he retires at age 65, his account is worth $2,308,216. That's $69,488 less than he would have had otherwise. Were Robert's one-year disability to occur earlier in his life, at age 40, the loss would total $114,768.
Things get even worse for Robert and his family if his disability lasts five years at age 50 (leading to an eventual loss of $315,059) or five years at age 40 (a loss of $520,358).
If you think those numbers are staggering, take a look at this scenario. At age 35, Robert withdraws $60,000 from his investments to cover his financial needs as a result of a disability lasting one year. The $60,000 would have grown to $2.8 million over the next 50 years (by age 85) at an 8% average rate of return. This would mean his heirs would have $2.8 million less to inherit.
And these are by no means remote possibilities. At age 35, Robert has a 20% chance of being disabled for one year and a 13% chance of being disabled for five years during the remainder of his career, according to the 1985 Commissioner's Disability Income Table.
Robert's scenario illustrates that there is a great need beyond traditional disability income insurance, a need almost entirely unmet in the marketplace. Most Americans, even if they have the foresight to own DI insurance, probably have never thought about the impact disability could have on their retirement savings and whatever inheritance they hope to leave to family members.
Contribution Protection is the Key
In my practice, every client who qualifies for retirement contribution protection purchases it. They're looking at the big picture in protecting their income and providing a legacy. When they realize this product is so inexpensive, they just grab it.
This new kind of disability coverage replaces retirement plan contributions up to 100%, including employer contributions. Payments go into an irrevocable trust managed by the insurance company. Participants choose their own investments and should be carefully advised on tax consequences, because the trust is a non-qualified plan. Payments begin when a person reaches full retirement age.
A good plan will offer a rider allowing the participant to increase his or her coverage limit without having to undergo another medical exam. As we get older, we're more likely to develop conditions that make us uninsurable. Rather than risk being turned down for more insurance later, most of my clients opt to secure this protection now, when it is particularly inexpensive.
For example, one of my clients is a 47-year-old male who pays about $4,000 annually in premium to cover a yearly disability income benefit of nearly $62,000 -- conceivably $1.4 million over a lifetime. Adding a second policy to protect his retirement contributions (which equal $8,640 a year) increases his premium cost by only $500. The combined premium for both policies accounts for only 4.8% of his $100,000 income, a fraction when my client considered the potential lifetime shortfall.
While discussing the new array of disability products with your clients, be sure to pay particular attention to those clients who are partners in small businesses. They have a special need for disability buyout insurance as a means of preserving wealth. Such insurance helps buy out a partner who becomes totally disabled. The elimination period is usually 12 months. Without coverage, the remaining healthy partners are forced to deplete retained earnings, or incur significant debt (if available), to buy out the disabled partner. Such a move could at the very least deprive the business of vital growth capital; at worst, it could threaten the viability of the firm.
What Clients Deserve
Businesses, just like individuals, do best when they don't have to borrow against their financial future to pay the costs of disability. It's far better to transfer that responsibility to the insurance company. Those who do that potentially can accumulate much more money for retirement and give themselves a better chance to pass an inheritance to loved ones.
As a Registered Financial Planner, it's my professional responsibility to talk about disability with every client who walks through my door. I've even had to push the issue with my own family. My father wanted to cancel a disability policy years ago. I talked him out of it, and now he's grateful. He recently developed a problem with his vocal chords that made him unable to work at his phone-based job. He's filing a disability claim worth $24,000 a year. That may not sound like a lot of money, but it's $24,000 that he won't have to liquidate out of his stock portfolio to survive. And it's fortunate for me -- a "living inheritance" of sorts -- that I don't have to spend my own money to support him.
For all the media attention about an aging society's need for long-term care insurance, people need disability insurance, too, and not just to protect income. Yet the subject is not raised enough by financial advisers. Our clients deserve to know the risk disability poses to their health, their savings, their businesses, and their heirs. And they deserve to know what their options are for mitigating that risk. Given the right products and a thoughtful perspective, they'll thank you for the chance to do something about it.
Larry Saffer, RFP, is president of The Saffer Financial Group, Inc., and a financial representative and adviser with National Planning Corporation (NPC), an agency of The Guardian Life Insurance Company of America. Mr. Saffer entered the financial services industry 20 years ago and is a multi-year member of the Million Dollar Round Table. He also has earned NPC's disability associate of the year and agent of the year awards. He is a Registered Financial Planner and holds the Series 6, 7, 22, 63, 65, and 215 licenses.
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS), 1801 Centrepark East, Suite 140, West Palm Beach, FL 33401, (561) 688-0300, Financial Representative, The Guardian Life Insurance Company of America, New York, NY. Securities products/services and advisory services offered through PAS, a registered broker/dealer and investment adviser. PAS is an indirect, wholly owned subsidiary of Guardian. The Saffer Financial Group is not an affiliate or subsidiary of PAS. PAS is a member NASD, SIPC
