The Pros and Cons of Retirement Protection Riders for Disability Policies

Traditionally, an individual disability insurance policy is designed to pay out benefits to replace lost income if a physician becomes too sick or injured to work in their specialty. When determining their ideal benefit amount, many physicians only take into account their most basic living expenses, such as bills, rent, and groceries.

While it is essential that your benefit amount covers these essential expenses, it’s also important to remember that disabilities can interfere with your earning ability for years at a time. Living off the bare minimum benefit amount can have long-lasting impacts on your financial future if you are unable to contribute to your retirement plan during the course of a long-lasting disability. That’s where the retirement protection riders are designed to help.

What is disability retirement protection?

A retirement protection rider is a provision added to an individual disability insurance policy that replaces missed payments to retirement accounts caused by a disability. If a doctor is unable to contribute to an IRA, 401(k), or similar plan due to a disability, the retirement protection rider will fund equivalent payments into an irrevocable trust during the disability claim. The policyholder can invest the benefits paid to the trust as they wish, similar to IRA contributions.  The money held in the trust pays out to the policyholder during retirement.

Benefits of Disability Retirement Protection

A disability protection rider is most valuable to a policyholder in the event of a long-term or permanent disability. If a disability only prevents you from contributing to your retirement accounts for six to twelve months, you may be able to bounce back financially without any major changes to retirement goals by being able to do some catch up contributions. However, if you lose several years or more of retirement contributions, the results could be catastrophic for your ability to retire. In this case, disability retirement protection can help you build a nest egg to supplement your income during retirement. 

Here are some of the other beneficial features of a retirement protection rider:

• It can provide a source of income after your disability benefits end. The majority of long-term disability insurance policies stop paying benefits when the policyholder reaches the age of 65. The money from your retirement protection trust can help you cover the cost of living expenses during retirement.

• The money won’t be lost if you pass away before retirement age. In the event that a policyholder dies before the age of 65, the money within the trust goes to their estate or beneficiaries. 

• Benefits paid to the trust are tax-free. As long as your policy premiums are paid with after-tax dollars, all payments made into the trust are tax-free. However, investment earnings within the account are subject to taxes.

Drawbacks of Disability Retirement Protection

It’s important to note that retirement protection riders are not the only way to protect your retirement plan in the event of a disability. The most common alternative is to simply opt for a larger benefit amount from your policy to cover both essential living costs and retirement contributions while you are on claim. This approach certainly can help you get more cash flow so you can make up for lost contributions into employer retirement plans while disabled. It doesn’t offset the tax deferred or tax free accumulation of the assets since you won’t have earned income that can be contributed toward a qualified plan. To make up for this shortfall you can adjust your benefit amount slightly higher to account for the drag from capital gain taxes. 

Retirement protection riders also include several terms and stipulations that deter some policyholders. Here are some of the most commonly cited downsides to a retirement protection rider:

• Retirement Protection terms can vary widely from base policy terms. In many cases, key terms such as benefit periods and even disability definitions can differ between the base policy and a retirement protection rider. Carefully examine the terms of any potential rider to understand how it defines own-occupation coverage and how long it will pay benefits.
• Benefits are limited to what you currently contribute to your retirement accounts. The amount of retirement protection benefit received is based on what the policyholder contributed to retirement accounts prior to the onset of the disability. Think of it this way: If you were only making 50% of the maximum annual 401(k) contribution while you were earning a full income, you can’t suddenly insist on getting the full maximum contribution amount deposited into the trust when you become disabled. 

• You can’t access funds before retirement age. This could be good or bad, depending on your financial situation. If you are easily tempted to dip into long-term savings, it could be helpful to have guaranteed money set aside for retirement. However, if your policy benefit amount is not enough and you really need money, you’ll be unable to access trust money for emergencies.  

• You may have to pay fees for the trust management. There may be hidden fees associated with trust management for retirement protection accounts. Ask your agent or advisor about these fees to avoid being surprised by any additional management expenses.

The Bottom Line

To determine if a retirement protection rider is right for you, make sure you speak with an independent advisor rather than a captive agent to crunch the numbers. If the cost of buying a policy with a bigger benefit amount is less than or similar to the cost of adding the retirement protection rider, just opt for the larger benefit amount.

However, if increasing your benefit amount would increase your monthly premiums more than adding retirement protection, you may want to go with the rider. Additionally, if you already have a disability policy but do not have the option to increase coverage, you can purchase retirement protection as a stand-alone policy to supplement your coverage. 

At the end of the day, there are multiple ways that physicians can protect their retirement in the event of a disability. The most important thing is that doctors can continue to save for retirement even if they become too ill or hurt to work. If you’re considering retirement protection, talk with a financial advisor to discuss the advantages and limitations of these disability riders.