Retirement Protection Rider: Should you buy it?

None of us know what tomorrow holds, which is why having a disability insurance policy is essential for those who wish to protect their income in the case of a long-term disability. It is important to not confuse a life insurance policy with a death benefit and a disability insurance policy.

If you suddenly find yourself with a long-term disability that would keep you from earning wages through your job, disability insurance would supplement your lost income. The supplemental income from disability insurance (primarily in the form of a monthly benefit) can be used to cover your cost of living as you take the time from work to heal. However, health care and other related costs quickly can prove that this primary benefit is unsatisfactory.

What is a Retirement Protection Rider, and why would I consider one?

With long-term disability insurance comes the opportunity to customize your policy to fit your specific needs. These customizations, or riders, can expand your disability insurance coverage in certain areas that are a priority for you. However, while some riders are free, others can significantly raise your premium rates, so choosing your needed riders is essential.

When someone finds themselves abruptly out of work due to a long-term disability, the first thing that likely crosses their mind is income. However, many people fail to consider the effect long-term disability might have on your retirement savings.

A Retirement Protection rider is an optional rider on an individual disability insurance policy. A Retirement Protection rider, when added to an in force disability insurance policy, would cover payments to your 401(k) or IRA that otherwise would be missed due to your lack of income.

How does the Retirement Protection Rider work?

The primary function of a Retirement Protection rider from your insurance company within your disability insurance policy is to help continually make deposits into your retirement fund. After an elimination period (the time period between making a claim and receiving an insurance benefit), the rider will begin to provide a monthly benefit to replace a portion of your previous monthly retirement contributions. Many people do not consider the long-term financial repercussions of being on disability leave. It may take years for your finances to bounce back after a disability leave, and your retirement fund may bear the brunt of those consequences.

Your disability insurance payout would ideally cover all your bills and basic living expenses, but they likely will leave next to nothing for your future financial planning. In addition, living with a prolonged disability might mean living without any safety net for tomorrow. However, adding a disability retirement protection rider to your existing disability insurance policy may help you cover all of your bases.

When a disability insurance policyholder is out of work for a prolonged injury or ailment, they likely would be unable to make payments to their 401(k). However, paying for a higher monthly premium with a disability retirement protection rider, those missed payments would be paid matching funds into an irrevocable trust. The payments will be held in the irrevocable trust throughout the policyholder’s disability claim(In contrast to normal income protection disability insurance, where you’d receive the benefit payments directly.) Afterward, the policyholder may invest their disability retirement protection rider payout however they wish, typically back into their retirement plan.

Should I purchase a Retirement Protection Rider?

As with most insurance products, you should only purchase a retirement protection rider if you feel the benefits are great and you can afford the higher monthly premium. If your long-term disability has a benefit period of six to 18 months, your retirement plan and other finances might have time to bounce back before you reach retirement age.

However, if your prolonged disability were to keep you from making your retirement plan payments for longer than that, you could be looking at a crushing financial setback and significantly change your retirement plan. A Retirement Protection rider from your insurance company can help adjust your disability income benefit amount, provide you an additional annuity to help you save a nest egg for retirement while experiencing long-term disability, albeit for an additional cost. You will get some extra income protections with this benefit rider,

An additional benefit to purchasing a retirement protection rider from your insurance company would be that if your disability benefits were to run out before you were able to return to work, you would be able to use your retirement protection to supplement your lack of income. Also, if a policyholder were to die before 65, the cash value of their retirement protection rider would be distributed back into their estate or to their beneficiaries. It should also be noted that the money paid to your retirement trust would be tax-free. However, the investment earnings within the retirement account would be taxable.

When considering retirement planning in connection with your disability insurance policy, it is important to remember that retirement protection riders are not your only option for optional riders or maximizing your total disability benefits. Due to the high premiums often attached to retirement protection riders, you may consider a more significant disability policy.

Instead of paying into an expensive retirement protection rider, you could use that money to purchase a more substantial disability policy with a higher payout. The more extensive disability policy would likely be able to cover both living costs and retirement payments. Retirement savings may seem like a minor issue today, but disability benefit money primarily pays out until 65. After that, you will be left with only Social Security Benefits and no insurance benefits if you have no further savings.

One possible downside to purchasing a larger disability insurance policy form your insurance company over a retirement protection rider is that the payments are not automatically put into a separate trust. Some policyholders may find that taking a portion of their payout and setting it aside is not easy, but willpower can payoff substantially. It would be the policyholder’s responsibility to take that portion of the payout and set it aside for their retirement future.

It should also be noted that retirement protection riders only contribute what you were contributing at the time of your disability leave. This means that even if you wanted to, you could not up the amount of money being set aside for your retirement, which can be a severe problem if you are unable to work for years.

It is important to receive legal advice and speak with a financial professional regarding the specifics of your policy and rider. A financial professional can help you determine when and how much income tax to pay.

Final thoughts

Disability insurance policies are a great way to protect yourself in the case of a long-term injury or ailment. Your disability insurance policy payout can help with your essential living expenses and bills. However, standard disability insurance coverage does not contribute to your retirement plan.

Suppose you are concerned about missing your retirement savings payments while on long-term disability; you may consider purchasing a retirement protection rider or just purchasing a more extensive disability policy. A larger policy payout will save you the money you would have spent on a retirement protection rider.

Joshua Holt is a licensed insurance agent (License #2785989) and founder of Biglaw Investor and Sidebar Insurance LLC, an insurance agency created by lawyers, for lawyers. His insurance expertise lies in the areas of life and disability insurance, particularly covering lawyers, doctors and other high-income professionals. Prior to Biglaw Investor, Josh practiced private equity mergers & acquisition law for one of the largest law firms in the country.