Disability insurance for retirement account contributions

This type of disability insurance can make sure you're still contributing to your retirement account even if you're unable to earn an income.

Amanda Shih author photoElissa


Amanda Shih

Amanda Shih

Editor & Licensed Life Insurance Expert

Amanda Shih is a licensed life, disability, and health insurance expert and a former editor at Policygenius, where she covered life insurance and disability insurance. Her expertise has appeared in Slate, Lifehacker, Little Spoon, and J.D. Power.

&Elissa Suh

Elissa Suh

Senior Editor & Disability Insurance Expert

Elissa Suh is a disability insurance expert and a former senior editor at Policygenius, where she also covered wills, trusts, and advance planning. Her work has appeared in MarketWatch, CNBC, PBS, Inverse, The Philadelphia Inquirer, and more.

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If you can’t work because of a disability, not only will you lose your income, you’ll also miss the opportunity to save for retirement, like by contributing to a 401(k) or IRA. Disability insurance can help replace your income, but since it only covers a percentage of your earnings, you may not have enough money leftover to fund your retirement account. If you want to protect your potential retirement savings, you should consider getting retirement protection disability insurance.

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When you become disabled, a retirement protection policy begins making benefit payments to a trust fund to replace what you’d usually contribute to an individual retirement account or 401(k) while you were employed. Retirement protection insurance policies can help you prepare for retirement, but they're not suited for everyone. You most likely won’t benefit from such a policy if you haven’t purchased maximum coverage from your traditional disability insurance.

Key Takeaways

  • If you are totally and permanently disabled, the IRS allows you to make penalty-free early withdrawals from your retirement plan.

  • Disability income insurance replaces your income so you don't have to dip into your retirement savings.

  • Adding a retirement protection rider to your disability policy helps you save for retirement when you can’t work.

  • Retirement protection disability insurance is different from an annuity, which pays a fixed amount and supplements your retirement income.

401(k) and disability 

When you become disabled, you can make withdrawals from your 401(k) or other qualified retirement plans (like IRAs, SEPs, and SIMPLE IRAS) without paying a penalty. Usually when you take money out of your retirement account before you turn 59 ½ you have to pay a 10% penalty.

In order to avoid paying the early withdrawal penalty, you must meet the definition of total and permanent disability set by the IRS, which considers you disabled if you can’t perform substantial gainful activity because of your physical or mental condition — and your condition will last indefinitely or result in death. You must submit documentation from a doctor and file IRS Form 5329.

If you dip into your 401(k) savings early, you may not have enough left to fund your retirement. Getting long-term disability insurance protects your income, and your retirement contributions, when you become disabled, so you don't have to make any unnecessary hardship withdrawals. The licensed experts at Policygenius can help you compare quotes and find a policy that meets your needs. 

How retirement protection disability insurance works

When you become disabled, retirement protection disability insurance pays you a benefit to replace the retirement contributions you’d normally make before you became disabled. 

Insurance companies may offer disability retirement protection as its own long-term disability policy or as a rider that you can add to  the coverage you already have. 

After you file a disability claim, the insurer pays disability benefits for retirement protection insurance into a trust account, which you can access when you retire. (With regular income protection disability insurance, you’d receive the benefit payments directly.) You can choose how the money is invested based on your own risk preference, the same way you would with when you contribute to your 401(k) or IRA.

The benefit amount should roughly account for your retirement contributions, plus what's matched by your employer. The amount of coverage you purchase can't be more than the IRS's maximum contribution limits for individual retirement accounts, which is $6,000 in 2022. Payments to the trust will end if you recover from your disability and can continue making contributions to your retirement account as normal.

As with traditional disability insurance, insurance for retirement contributions has an elimination period, which is the time you have to wait after becoming disabled before benefit payments begin. Typical elimination periods are either six months or one year.

Taxes on retirement protection disability benefits

Long-term disability insurance benefits are not taxed if you paid the premiums with your after-tax dollars. The same is true for benefits made to a trust through your retirement protection disability policy. However, you will pay taxes on benefits if you paid your premiums with pre-tax income (or if your employer paid the premiums), and you'll also pay taxes on your investment earnings.

Do I need retirement protection disability insurance?

If you have maximized your income protection disability insurance, then you may benefit from purchasing retirement account contributions protection. However, most people won't hit that maximum, so they won't need retirement protection disability insurance.

The maximum benefit amount for income protection disability insurance is usually around $20,000 per month. Because your disability insurance should replace 60% of your pre-tax income, you would have to be earning an income of $32,500 per month, or $390,000 per year, to qualify for the maximum benefit amount.

A licensed representative at Policygenius can help you find a disability policy that fits your income and insurance needs.