Did you know that your paycheck is the single most valuable asset that you have? Just think about it. Everything that you do in life revolves around your paycheck – whether you have enough money to travel, pay off debt, move to a new city, go back to school, or even simply to pay your monthly bills. You need your paycheck to support the lifestyle you live and to help fund the lifestyle that you hope to live down the road.
Your paycheck is also a fundamental piece of your retirement plan. With your paycheck, you contribute to your 401(k) plan, IRA, ROTH and a portion of your paycheck goes towards your Social Security check (which you hope is there when you need it).
We all go to work and do our best so we can increase our paychecks and improve our overall lifestyle. What happens though when that paycheck disappears due to an untimely disability? Most people are left scrambling with very little savings to help them get by.
The Case for Disability Insurance
As Americans, we have the high honor of being the worst savers. Most people don't have enough saved for even life's smallest emergencies, like an untimely car repair or a plane ticket to visit a loved one. Little savings coupled with a disability could be enough to not only wreck your financial plan but cause financial devastation that 's hard to recover from.
That won't happen to you, though, right? Well, think again. The fact is that the odds of having a disabling injury are 1 in 3, compared to 1 in 20 odds for totaling your vehicle. If a 25-year-old who makes $50,000 a year at her job has a lengthy disability, it is estimated that the potential loss of earnings could be somewhere around $3.8 million.
Disability insurance is one of the best investments you can make in your financial plan to help ensure that a paycheck is there when you need it. It's a type of insurance that many people don't understand and therefore decide not to purchase. It can be confusing- there are lots of types of disability insurance and many different riders and exclusions to the policies. It can also be expensive depending on your age, health, and choice of career. But there are many ways to lower the cost of a disability insurance policy.
How one simple disability wrecks your financial plan
As a Certified Financial Planner Professional, I get an up close look at just how valuable disability insurance can be in a financial plan, and conversely, how not having disability insurance can capsize a plan in a matter of minutes. Here are a couple of cautionary tales that are fictionalized composites of the kinds of stories I come across all the time in my practice.
Meet "Jessica and Dan"
Jessica and Dan were your model couple on paper. Both were in their mid 40s, had great careers and very little debt. Jessica was a fashion stylist, and Dan ran a real estate business. They wanted me to help them better plan for their retirement needs, as they both hoped to retire early around 55. They wanted to travel the world and start non-profits for children's education in Africa. They had already begun saving in their 401(k) and Dan's SEP- IRA accounts for retirement, and they put away as close to the maximum as they could each year. Their cars were paid off and they only had a small amount left on Dan's MBA student loan.
Overall, not too bad considering their ages and goals, right?
Jessica and Dan came to visit me to get an expert's opinion on their strategy. At first glance I was impressed. Then I noticed that neither one of them was carrying any disability insurance. They were very turned off by the idea of purchasing a plan because they didn't want to pay the annual premium. The plan would have provided $10,000 in tax-free monthly income had they made the purchase, but they decided they were willing to take the risk.
You probably know where this story is going, but I will tell it regardless.
About a year after working with them, I got a call from Jessica that Dan had been disabled in a boating accident and was semi-paralyzed from his neck down. He was 45 and was out of work for at least a year, if not more, in and out of the hospital trying to recover. He lost the mobility of his legs, and he could barely operate his arms at times. On top of steep medical bills, they lost Dan's lucrative income from his real estate practice almost instantly. I helped them shuffle around assets as best as possible, which bought in around two years to three years of income before they would run out.
In an instant, their dreams of any retirement went out the door. Jessica had to take a second job just to make ends meet. It was heartbreaking to watch this young couple suffer defeat over a purchase that they could've afforded and would've provided much-needed income.
Stacey knew how important disability insurance was to her financial plan and purchased a policy in her 40s. She had learned about it from a friend who told her what riders and exclusions to purchase and she was confident that she was making a wise financial decision.
When Stacey met with an insurance agent, she was concerned about price and decided to buy an individual policy that was similar to her group policy that she had at her old company. This policy contained an "any occ" disabling definition in her policy, which meant that if she were disabled but could do any gainful job in the workforce (even flip burgers at McDonald's) her disability insurance would not pay out. She would need to be totally and fully disabled, like Dan, in order to collect her benefits.
Unfortunately, Stacey was diagnosed with diabetes in her mid-50s, and it came on fast. She had trouble walking, and suffered severe nerve damage which made it difficult for her to work. When Stacey came to me as a client, she was frustrated because she needed to use her disability insurance but had just learned the true definition of an "any occ" policy. Her insurance company would not pay out benefits, because, in their opinion, Stacey had plenty of employment choices.
In Stacey's situation, it's heartbreaking to see someone who thought they were making a wise purchase secure their financial plan but ended up in the same position as those who don't have insurance. She, unfortunately, had to burn through her retirement savings just to make ends meet. She sold her house and many of her possessions to get as much cash flow as possible, and ended up moving in with her sister who could help take care of some of the expenses of living.
Financial planning isn't just about saving money in your 401(k), IRA or ROTH. That's a great start, and you should save as much as you can into these retirement accounts for as long as you work. However, smart financial planning means that you take a look at all of your areas of risk – those places that leave you exposed. It's a law to have car insurance, but most of us have car insurance because we understand how costly it could be if we injured ourselves or someone else in a car accident. It's time that we also realize how expensive a disability could be to our financial plan, and our #1 asset, our paychecks.