Saving for retirement can be challenging even in normal times. During a period of disability, saving for retirement may seem impossible. Disability insurance retirement income protection provides a solution. In a Bankrate survey, 55% of working Americans said they’re behind on their retirement saving goals. And what about people who can’t work due to an injury or illness? A disability can upend retirement plans.

As an example, imagine a 50-year-old woman, let’s call her Katherine, who is behind on her retirement savings. She isn’t too worried because she has a good job and believes she should be able to catch up over the next 15 years. Then, she experiences a stroke and can no longer work.

Suddenly, saving for retirement isn’t even on the table—she’s struggling just to cover her daily expenses. And since the Social Security Administration says one in four of today’s 20-year-olds will become disabled before age 67, this scenario isn’t far-fetched. Disability is a common threat – and one workers need to prepare for.

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Long-Term Disability Insurance and Individual Disability Insurance

  • One of the main ways workers can prepare for the threat of disability is by purchasing disability insurance. If a person is unable to work due to a qualifying disability, the disability insurance policy will provide a monthly disability benefit. Policyholders can use this money however they want; for example, to pay their mortgage or cover groceries and utilities.
  • Disability insurance provides important protection, but the monthly benefits only replace a portion of the policyholder’s normal income.
  • How much income the policy replaces will depend on its terms. Group long-term disability insurance policies often only replace 60% of the worker’s income, and this benefit is subject to income taxes. Individual disability insurance policies often replace a greater portion of income than group long-term disability insurance policies. People with work-based long-term disability insurance may supplement their coverage with an individual insurance policy. However, insurers will never write a policy that replaces 100% of a person’s income.
  • There are good reasons for this. For instance, if workers could receive 100% of their income through disability benefits, they might be unmotivated to return to work. This could open the door to fraud. Limiting the percentage of income that insurance replaces also helps insurers manage their risk and keep premium costs down.

Despite the fact individual disability insurance does not replace a worker’s regular income completely, the monthly benefits are extremely helpful – they can mean the difference between getting by and facing foreclosure and bankruptcy. However, policyholders may still need to cut some expenses. For many people, that might mean not contributing to a retirement fund.

Retirement income protection offers a solution to this problem.

How Retirement Disability Insurance Works

Retirement plan disability insurance can contribute to a retirement plan when a policyholder is unable to make contributions due to a total disability. The benefits go into a trust for investment, and policyholders can receive the funds when they reach retirement age.

Returning to our example, let’s imagine Katherine has a disability insurance policy and disability insurance retirement protection. She’s contributing to a retirement plan (it could be a 401(k), IRA, or another type of retirement plan covered under such policies) when she experiences a total disability and can no longer work. She qualifies for disability insurance benefits, which she receives every month after the elimination period and through the benefit period. She also qualifies for retirement protection benefits. As these benefits are paid into a trust, she can’t use the money now. However, she enjoys peace of mind knowing she’ll have these funds to draw on during retirement.

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Isn’t typically portable

This means workers who switch jobs may suddenly find themselves without coverage. Plus, securing good rates and robust coverage may be more difficult if the worker has developed health problems. Individual disability insurance provides portable coverage.

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May not provide enough coverage

Policies may only replace 60% of the policyholder’s salary – and that amount can be further reduced by monthly benefit caps and income taxes. Individual disability insurance can cover a greater percent of the person’s income and the disability benefits are not typically taxed if the policyholder pays monthly premiums with after-tax dollars

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May have strict coverage terms

Workers may be unable to select the terms and riders they want. By purchasing individual disability insurance, they have access to various policies from top disability insurance companies and can select the coverage that meets their needs.

The Nitty Gritty of Retirement Protection Coverage

As with any type of policy, it’s important to consider the details of coverage and the possible implications if you ever have to file a claim.

Retirement protection benefits are typically tax free.

This is because you usually pay the premiums with after-tax dollars. Also, these policies are usually portable, meaning they’re not tied to a job and the policyholder can keep coverage when switching jobs.

There are limits on the monthly benefit amount and eligibility requirements for coverage. There are also requirements for claiming benefits and may be restrictions on the types of disabilities covered. Retirement income protection typically replaces the retirement contributions policyholders would be making if they weren’t experiencing a disability. It’s not a substitute for a 401(k) or other retirement savings plan – it’s just protection.

As always, read the policy terms and review your options carefully.

Retirement Protection Rider

Some disability insurance companies offer a retirement protection rider. This is a provision you can add to an individual disability insurance policy to add extra benefits. Other riders include student loan riders and cost-of-living adjustment riders. Adding a rider may increase the total premium cost of a policy, but it can also be a great way to obtain the benefits that matter to you.

Who Needs Retirement Protection?

Some disability income policies have benefit periods that last until retirement age. Once you reach that age, the benefits end. If you don’t have any savings, you could face financial hardship – unless you have retirement protection.

Social Security benefits may help, but the modest amount may be insufficient. The Social Security Administration says the average monthly benefit for all retired workers was $1,657 as of January 2022 and the average benefit for all disabled workers was $1,358. As well as being only a small amount, you will only receive something if you qualify for benefits (many Social Security Disability Insurance benefit applications are denied).

For many workers, a retirement protection disability insurance policy is a smart idea. To determine whether it makes sense for you, consider the following:
  • Are you currently making retirement plan contributions? You may want to protect these contributions with insurance.
  • Do your retirement plans depend on your capability to continue making retirement plan contributions? Think about what would happen if you never made another contribution to your retirement plan because of an injury or illness. If you already have enough saved, you might not want to spend on premiums for retirement protection. However, if you need to continue contributions, retirement protection may be a wise investment.
  • How would a long disability impact your retirement plans? Sometimes, saving for retirement has to take a backseat to financial emergencies. If you can’t work for a year or so, your retirement savings might take a hit, but you may be able to recover. A long-lasting disability, though, could be different. If you don’t have another way to cover your retirement costs, you may need retirement protection.
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  • Many workers overlook the risk of disability when saving for retirement. Insurance agents can help by educating their clients about retirement income protection.
  • Retirement income protection can also be a good option for groups of employees. Get the Case Study to see how.