Protecting Your Income in the Event of a Disability

Protecting Your Income in the Event of a DisabilityPlanning for this potential risk is critical for corporate executives

Key points

• As a corporate executive, the amount of your future earnings can be negatively impacted if you become disabled through illness or injury

• When considering the effects of a disability, you should first examine what existing coverage you have in place

• It’s extremely important to identify the risks you face from a disability, and establish a plan to reduce this potentially devastating situation

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Continued

As a corporate executive, you have the prospect of earning a significant amount of money during your working career. This amount of future earnings can be negatively impacted if you become disabled through illness or injury. It’s imperative to examine the type of disability benefits you have as an executive and confirm that your income is adequately protected.

Assessing your coverage

When considering the effects of a disability, you should first

examine what existing coverage you have in place. There are

two distinct types of employer-provided plans that can provide

income protection: short-term and long-term coverage.

Short-term disability: Companies can provide short-term

disability benefits to executives under one of two approaches.

They may have a sick pay plan, which usually covers the

replacement of lost income for a limited period of time starting

on the first day of disability. The other option is a short-term

disability income insurance program, which usually provides

benefits to replace a portion of the executive’s lost income and

often requires a waiting period before the benefits start.

Long-term disability: Long-term disability income plans

typically have a waiting period of between three and six

months, with a six-month waiting period more common. The

length of the payment for the disability benefits is typically

until age 65 for either sickness or accident.

Definition of disability

Most short-term disability income insurance contracts define

disability as the total inability of the executive to perform

each and every duty of his or her regular occupation. Long-

term group disability income contracts typically will use the

“own occupation” definition of disability where the executive

would be unable to perform the duties of his or her regular

occupation for the first 24 to 36 months of disability. If

disability continues past 24 to 36 months, then the definition

of disability changes to the inability of the executive to engage

in any occupation for which he or she is qualified by reason of

training, education, or experience.

Benefits

Most employer-provided disability income plans base benefits

on a single percentage of regular earnings, excluding bonuses,

commissions, and incentive-based income. Short-term plans

can protect between 50-100% of base income. Long-term

plans will cover up to 66 2/3% of wages. During review of

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your long-term benefits, you will want to see if your plan has

a monthly maximum. Some plans may cover up to 66 2/3% of

your earnings but may have a monthly maximum of $10,000.

Example: Mrs. Executive has a wage of $200,000 and typically

earns a bonus of $100,000. She has a long-term disability

plan that pays 66 2/3% of her wages with a maximum benefit

of $10,000 per month. Based on her total compensation of

$300,000, she would only have income protection of 40%,

since the plan has a maximum of $10,000 per month and

excludes her bonus. If accounting for taxes, the income

replacement ratio is even lower.

Supplemental benefits

Some disability plans are designed to “carve-out” benefits for

the corporation’s key executives that are different from what

other employees are eligible for. This type of executive plan may

provide enhanced benefits in the form of coverage for a larger

percentage of earnings or a more liberal definition of disability.

Individual disability income protection

If you have reviewed your existing disability income insurance

through your employer and determined that the coverage is

inadequate, then you can enhance your coverage through an

individual insurance plan. Provisions of individual policies include:

Definitions of disability: Individual policies provide the insured

with the superior “own occupation” definition of disability. If

you are totally disabled and unable to perform the substantial

and material duties of your regular occupation, the insurance

company will pay the full benefits even if you return to work in

another occupation.

Partial disability: Unlike group plans, the advantage of

individual disability policies is that they provide benefits for

executives even if you are partially disabled or have residual

effects from your previous disability. Residual disability is

defined as a loss of income due to the loss of ability to perform

some of the duties of your own occupation.

Cost of living adjustment: In the event of a long-term

disability, the cost of living benefit in an individual plan will

increase the monthly payment based on the rate of inflation.

This can help protect the benefit from the erosion of value due

to inflation.

Age of corporate executive: The younger you are, the more

detrimental a long-term disability can be to your financial

well-being. Based on your work history, the Social Security

disability benefit may be low, or you may not even qualify

for a benefit. The amount of retirement savings may also be

low since participation in the plan has not been going on for

very long. Even if you have a significant amount of disability

income benefits, most plans only pay until full retirement

age, at which point you are then deemed to have retired. This

could be problematic since the amount of retirement savings

would be low due to lack of contributions during all the years

of disability. If you are concerned about underfunding your

retirement plan due to a long-term disability, you can obtain

a separate disability income policy that would pay retirement

contributions into your retirement plan.

Examining your disability income insurance is a necessary

part of risk management in the financial planning process. It

is extremely important to identify the risks you face from a

short- and long-term disability and establish a plan to reduce

this potentially devastating situation.

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