Using Disability Insurance to Protect Your Client's 401(k)

The Background

When an injury or illness occurs, employees without disability insurance often use their 401(k) accounts to pay themselves an income.

The Problem

Employees in their 30s have a lot going on, and disability insurance might not seem affordable. But robbing their 401(k) to pay expenses can have a long-term effect on their retirement. Let’s look at a strategy for keeping the 401(k) intact and still offering meaningful income replacement if a disability should occur.

The Client

Stephanie is in her early 30s and has been a nurse for five years. Additionally:

• Stephanie is currently contributing 7% of her salary to her 401(k)
• The hospital matches 100% of contributions up to 5%, but she’s concerned about having a stable retirement
• She’s worried that she can’t afford disability insurance, and she’s not really worried about becoming disabled

How it Works

The concept is simple. Instead of contributing 7% to her 401(k), Stephanie contributes only 5%, the amount matched by the company. The remaining 2% provides $1,500 each year, an amount Stephanie can use to purchase a disability insurance policy.

The Result

Stephanie was able to purchase a long-term DI policy with a monthly benefit amount of $3,500. This policy was a 90-day elimination period with a five-year benefit period. It also includes an additional benefit of $3,500 if she were to become catastrophically disabled until age 65. The cost of this coverage is $1,400 annually, allowing Stephanie to contribute $10,000 annually to her 401(k) — $5,000 of her own contributions and $5,000 from the company match.