Retirement Protection Insurance?
In our last two posts we discussed two different disability insurance policy riders that may help mitigate the problems that a disabling condition can create for your retirement planning. A graded lifetime benefits rider and a lump sum benefit rider offer two alternative solutions to the same problem, with one providing a reliable, steady income stream and the other providing a greater degree of financial flexibility. If neither of those options are particularly appealing, some disability insurance companies have created another product that, unlike lifetime benefits or a lump sum, is specifically tailored toward the retirement planning challenges posed by a total and permanent disability.
What Is Retirement Protection Insurance?
Retirement protection insurance was created by some insurers precisely to deal with these concerns. Depending on the insurer, this product may be offered as a standalone policy or as a rider to your existing disability insurance policy. The idea behind retirement protection insurance is to create an investment product that functions similarly to the qualified 401(k) you contribute to in your current occupation, allowing you to take advantage of both the market returns and employer contributions that you currently enjoy.
How does this work? If you become totally disabled and your claim is approved, your insurer will establish a trust for your benefit. Each month, benefits are deposited into the trust and invested in index funds and other investment portfolios similar to the options you have with your employer-sponsored 401(k). This product can cover up to 100% of your retirement contributions and 100% of employer contributions at a maximum of $50,000 per year. Under the terms of the trust, you will be able to access these funds after age 65.
At first glance, this product appears to solve the problems that a disability can create for retirement savings. Specifically, it appears tailor made as a substitute for your employer-sponsored 401(k), which you can no longer contribute to once you stop working due to a disability. However, there are some issues with this particular product that you will want to clarify with your insurer before purchasing it as a rider or as a standalone policy.
First, some insurers are using a different definition of disability for this product than for your standard individual disability insurance policy. In many cases, the definition of total disability for this specific product is narrower and more stringent (i.e. you must be unable to perform work in any occupation) than the specialty-specific own-occupation definition in most disability insurance policies purchased by doctors and dentists.
For example, assume you have an own occupation policy with this rider and due to your medical condition you are unable to perform your duties as an orthopedic surgeon. For three years you collect monthly benefits through your policy and also enjoy three years’ worth of contributions to the trust account established for your benefit by your insurer. After three years, you go back to work as a primary care physician. Because you are still disabled under the terms of your own occupation policy, you continue receiving monthly benefits. However, the retirement contributions to your trust cease because the definition of total disability is “any occupation.” Under this scenario, even though you are totally disabled for the purposes of your policy, you are no longer receiving the benefit of the rider you paid good money for because it measures your disability by a different standard.
Second, because the investment account is held in trust, somebody has to manage it. As a result, there may be fees associated with both the management of the trust and the investment account. Also, 401(k) accounts receive special tax treatment – as long as the money stays in your account it is allowed to grow tax-free without any capital gains tax levied against your investment returns. It may very well be that any investment account held in trust by your insurer through this insurance product will be fully taxed.
Before you purchase retirement protection insurance either as a rider or as a standalone policy, you will want to clarify the issues addressed above. Make sure you fully understand the terms (including the definition of total disability), the fees, and the tax implications of this product before you purchase it. Though initially it may look like an attractive option, the costs may outweigh the benefits, and other options to protect your retirement income may be a better solution for your particular circumstances and objectives.