In our last post we discussed how it can be difficult to save for retirement if your only income is your monthly disability benefits. One way to help ensure financial security into retirement age is to purchase a lifetime benefit option with an individual disability insurance policy. While older policies often featured full monthly disability benefit payments for life, newer policies insert qualifiers that limit whether a claimant will actually receive the full benefit amount for his or her lifetime. Our last post looked at the injury versus sickness limitation. In this post, we will be taking a look at another provision that limits lifetime benefits: the graded benefit rider.
Graded Lifetime Benefit Riders
Under the graded benefit rider, claimants receive benefits for life, provided they are disabled prior to a specified age and remain continuously totally disabled. However, the amount of the monthly benefit they receive varies based on how old the claimant is at the onset of his or her disability.
For example, a disability insurance policy may have a benefit period that ends at age 65, with a graded lifetime benefit rider (sometimes called a “lifetime extension for total disability”) that will pay 100% of monthly benefits for life if the policyholder is disabled prior to age 46. However, if the policyholder becomes disabled after age 46, his or her lifetime benefits will only be a certain percentage of the monthly payment.
Below is a provision from an actual policy, illustrating how benefit amounts are calculated under this type of rider:
Using this chart as an example, if your benefit payments are $10,000 per month and you become totally disabled at age 46 (100% under the policy) your disability insurance company will continue to pay you $10,000/month after you turn 65 for the rest of your life. If you become totally disabled at age 55, the percentage of monthly indemnity payable would drop to 50% and your disability insurance company would pay you $5,000/month after you turn age 65. If you don’t become totally disabled until age 64, the amount payable would only be 5% of your monthly disability benefit. In other words, you would have a year or less of monthly payments of $10,000, followed by monthly payments of $500.
While a graded lifetime benefits rider is one way to ensure that you continue to receive disability income after your standard benefit period ends, you must keep in mind that these payments may not provide much income if you become disabled later on in life.
Further, in order to achieve lifetime benefits under this rider, you must remain totally disabled. So, for example, if you return to work, were pushed off claim, or went into residual disability claim status, you lose the lifetime benefits. And even if you are later able to reestablish total disability, the lifetime benefit will be a lower percentage of the monthly benefit, because you will have re-set your total disability date for purposes of calculating your monthly benefit under the rider.
Lifetime benefits offer a way for policyholders to continue to collect at least some income after the benefit period of their disability insurance policy ends. However, when choosing a disability insurance policy, physicians and dentists must carefully consider their age at the time of purchase, premium amounts, and the policy language before buying a policy. Knowing how your policy’s lifetime benefits work is an important step in planning for your financial future.
In our next post we will look at another option individuals have to supplement their retirement income: the lump sum benefit rider.
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 disability 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 disability 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 disability 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 disability 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 disability insurance 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.
Graded Lifetime Benefits Rider
In previous posts we’ve talked about the importance of protecting your investment in your education and your career with an individual disability insurance policy. A vast majority of doctors and dentists purchase individual disability insurance policies to protect their financial security and standard of living in the event they become disabled and can no longer practice. However, one factor that many healthcare professionals may not take into account is the effect that a disability may have on their retirement. Most standard disability insurance policies pay benefits until the policyholder reaches retirement age – often age 65. However, that is where the financial protection of a standard individual disability insurance policy ends.
As long as you have an adequate individual disability insurance policy, your income will be sufficiently replaced during your employable years. However, many people overlook the fact that even with adequate income protection during the term of your disability insurance policy, a disabling condition can still seriously derail your efforts to financially prepare for your retirement years. If you had the foresight to obtain an individual disability insurance policy early in your career, you’ve likely been planning for your retirement as well by contributing to a qualified 401(k) plan or similar retirement vehicle.
However, you may not have considered the following scenario: at 50 years old you are suddenly no longer able to continue practicing dentistry due to debilitating back and neck pain. You’ve been contributing to your 401(k) for the last 20 years with employer-matched contributions. Your claim is approved by your disability insurer, but because you had to quit your job, not only is your employer no longer matching your contributions, but you can no longer contribute either because IRS rules prohibit contributions to a qualified 401(k) plan if you are not working. Your 401(k) is 15 years short of where it needs to be for retirement, and your disability insurance benefits stop at age 65. How do you continue planning for your “retirement” years?
Fortunately, there are several options available to you. First, many disability insurance companies offer a graded lifetime benefits rider. In exchange for an increased monthly premium, this rider extends your disability benefits from the standard policy term of age 65 or 67 to lifetime. With this rider, if you become disabled, you will receive your full policy benefits until age 65 or 67 (depending on your disability insurance policy). After that, you will receive a certain percentage of your full benefits for the remainder of your lifetime, based upon the age at which you became disabled.
With many disability insurance policies, the baseline age for graded lifetime benefits is 45 years old. Meaning, if you become disabled at or before age 45, your monthly benefits after age 65 will still be 100% of the monthly benefits you received before age 65. If, however, you become disabled after age 45, you will still receive 100% of your monthly benefit until age 65, but your monthly benefit amount after age 65 will be reduced by 5% for each 5-year period after age 45 that the disability began.
Using the example above, if you had a disability insurance policy that pays $10,000 in monthly disability benefits and became disabled at age 50, you would receive $10,000 a month from age 50 until age 65, and $9,500.00 a month for the remainder of your lifetime. If you became disabled at age 55, you would receive $10,000 per month until age 65, and then $9,000 per month for the remainder of your lifetime.
This rider is one solution for the difficulties that a disabling condition can pose to your retirement planning. It offers a secure source of income to supplement any retirement savings you’ve already amassed. However, it is not the only solution to the retirement income issue created by a disability. In the next few posts, we will evaluate two additional options: the lump sum rider and retirement protection insurance.