Disability Insurance: Making Sure the Income Stream Doesn't Run Dry

Company Plans Are Only Part of the Solution

If you think the disability insurance that your employer provides is all that you need, you may be in for a surprise.

  • All your disability benefits may generally not exceed 60–70% of your pre-disability earnings. While you think you may need less to live on, your actual living expenses could go up as a result of your disability. How will you make up for the shortfall? We don't recommend tapping into your savings.

IMPORTANT NOTE: Under current law, 401(k) plans, Keoghs, SEP-IRAs, and IRAs allow you to withdraw money before age 59½ without paying a 10% penalty tax if you become disabled. However, you will have to pay ordinary income tax on the taxable portion of the withdrawal. If the withdrawal is made from a Roth IRA, and the Roth IRA was held for five years, the withdrawal will be tax-free. Taking money out of a retirement plan puts your future retirement income in jeopardy.

IMPORTANT NOTE: When your regular wages stop and disability payments begin, contributions to company retirement plans might not continue. Future lost savings mean you'll have significantly less income in retirement. While you're disabled, you should plan on saving a portion of your disability income.

You should also consider these factors:

  • Your company disability plan probably does not have cost-of-living increases, which means your fixed-income will be worth less every year.
  • The company plan probably doesn't have any provisions to pay you if you are partially disabled.

Here are some additional disability insurance options to consider:

  • A policy you purchase on your own can offer you a plan that pays for partial loss of income (residual disability) and adjusts your benefit for annual increases in inflation (this may be costly).
  • A less expensive option is to consider purchasing disability coverage through an association. Association policies tend to be more restrictive, but they are less expensive.
  • And while you're considering options for yourself, don't forget to make sure that your spouse also has adequate disability coverage if he or she is employed.

There are additional financial basics that are equally important in reducing your risks of catastrophic financial loss when a disability strikes. Here are some things you should do before a disability strikes:

  • Establish an emergency fund to cover at least three to six months of expenses.
  • Work towards maintaining minimal consumer debt.
  • Understand how your company's medical insurance plans will be affected in the event you cannot continue to work. If your coverage is terminated after a period of time, you'll need to know what options are available to handle your medical expenses during a disability.
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