403(b) Story: Disability Protection
by Amy Irvine, CFP
Before you read this article, I want you to take out your bargaining contract. Now I want you to find the “disability” section. Still searching? Can’t find it? I’m not surprised. Many of the teachers that I work with are in the same boat; this is an area of risk that is often overlooked by my teaching population. They consider life insurance, retirement savings, paying down that pesky student loan debt, but what happens if disability strikes?
More Likely to Become Disabled Prior to Retirement Than to Die
Your State may offer some short-term disability, but often it is NO where near enough to cover your weekly/monthly expenses. How many of you have had a short-term disability (or will have)? More than you think, ever have a child or plan to? If the answer to this is yes, then you have experienced (or will) the inability to work for at least a short period of time.
Outside of child-bearing, you are much more likely to become disabled prior to retirement than you are to die (I know, I’m so blunt). So why do we focus so much on life insurance and not enough on disability. I believe it is because disability is not as cut and dry.
What is Disability?
So, first and foremost, what is disability? Break out the word – DIS-ABILITY; the ability to work is negated. But it’s not that simple. There is own-occupation and any-occupation disability. There is short-term or long-term.
Let’s break all these terms down:
- Own-occupation – the inability to perform the majority of the duties associated with your OWN occupation for which you have been trained and educated to perform.
- Any-occupation – the inability to work in ANY occupation that you could reasonably work in based on your education, training and experience.
- Short-Term Disability – this is usually for a temporary disability – be careful on this one because this term is defined by the policy. Each policy may have a different term defined, i.e. some are 30-days, 60-days, I’ve even seen 26-weeks.
- Long-Term Disability – this is for a longer or possibly permanent disability.
What Happens When You Are Striken With a Long-Term Disability?
These seem really simple, right? Now what happens if you are stricken with a long-term disability? Does your contract allow you to “retire” disabled and continue your health insurance? What about your pension amount, is it significantly reduced? What about your lost years of savings?
These are all important topics to be considered when planning for a disability. Some of this risk can be “delegated” or “shifted” via protection planning (i.e. disability policies), but of course there is a cost associated with that process (policy premium). The cost of the policy is based on medical underwriting and policy features selected. There are several combinations to consider! A few examples:
- You can select only long-term disability coverage and plan for short-term disability separately
- You can select only short-term disability and plan for long-term disability separately
- You can define when long-term disability kicks in and plan for out-of-pocket up to that point (i.e. that thing called an emergency fund)
- You can define the length of how the long-term disability will pay (to age 65 or only 2-years)
- You can select coverage if you can’t do your current job - i.e. if you have the inability to speak, does that mean you can’t teach? Maybe, maybe not. You might need to learn a new skill such as sign language, but you still know how to teach. It’s critical to understand what the terminology is if you buy a policy.
- You can select coverage if you cannot do ANY job, this generally means you are completely disabled, that even with retraining, you will not be able to work. Of course, this policy is going to be less expensive because most people that do become disabled are able to be retrained and can be contributors to the working world.
- What about the amount of the benefit? Can you live off 50% of your income, 75% of your income? What is your take home pay? How much wiggle room do you have in your budget for income loss?
- I asked the question above about what will happen to savings goals if you become disabled.
Riders That Can Shift Responsibility to Insurance Company But At a Cost
There are actually riders that shift the risk to the insurance company on this topic as well; the cost is more, but it is an option.
- Retirement Income Rider – if you become disabled, this will cover a portion of your retirement contributions
- Cost of Living Rider – Benefits will increase based on COLA increases
- Future Increase Rider (if your income goes up, you can increase coverage without a new medical exam)
- Unemployment Waiver – if you become unemployed, you don’t have to make the premium payments, but the coverage will continue
- Student Loan Rider – if you become disabled, this will cover the cost of the loan payments (remember if you have government loans, you may already have this protection).
Understand, there are benefits to having a policy that you pay for. Should you ever become disabled, then the benefits you will receive will not be taxable. So, if you selected 75% income replacement, you will receive the full 75%, not 75% minus taxes. If your employer pays for the policy, then the amount you receive will be taxed, for example if the employer pays for a 50% long-term disability policy, you won’t actually receive 50% in your hand. Instead it will be 50% minus taxes.
Where Do You Go to Get a Policy?
I’d be remiss if I didn’t say seek some professional fee only advice on this topic, they can help you navigate the waters of options. For example, often your Union will have options available for you to consider. One of the benefits of a group policy, is that often the under-writing is either not required or is minimal. Union’s generally negotiate a group rate for their members too, so it might be a bit cheaper than working with an insurance agent, but I always suggest shopping around. Just like with all other insurance, get multiple quotes from multiple sources.
What are some other options? When I’m working with a couple, I always look to see if the non-teacher spouse allows for adding a rider for spousal coverage. This is generally limited, but it can be part of the plan. It might be the short-term coverage, but you still need to seek long-term (or vice versa).
If there are medical issues involved, I’ll look to see if the biggest debts the couple have can get disability insurance on the debt through their financing company (this is usually available at the time of the loan issuance). I recently helped a couple refinance their mortgage for this exact purpose. It was clear there was a high risk and the underwriting was going to probably put them in a higher risk pool, so we used a home equity loan to pay off the mortgage and some consumer debt, and elected disability and life insurance coverage at that time. The couple still needs to plan for covering other expenses, but should the disability occur, they aren’t going to lose their home.
Plan Plan Plan
Don’t forget to plan for possible caregiving costs and lost income of your spouse if they need to work less to care for you, or you need to hire someone to help you.
Figuring Total Disability Need
Use this worksheet to calculate your disability need.