I recently completed the first phase of a study of the financial effects of disability on federal employees. The results may surprise you, as they did me.
I found that a five-year reduction in your income due to a temporary disability early in your career could reduce your standard of living in retirement by more than 50 percent.
This is even more surprising when you consider that this is after taking into account the maximum disability retirement benefits available under the Federal Employees Retirement System. I did not realize that a limited loss of income – limited in the amount of the loss and its duration – would have such a significant impact on the retirement standard so far into the future.
Consider a 30-year-old employee who suffers a 40 percent loss of income for one year, followed by a 60 percent loss of income for four years. My analysis shows that he can expect a 52 percent loss of spending power during retirement starting at age 65 – $42,300 per year compared with $88,000 if he had not been on disability. He can expect a 91 percent reduction in the value of his investment portfolio at the end of his life – $103,510 compared with $1.1 million if he had not been on disability.
To put this in perspective, imagine reducing your standard of living in retirement from $100,000 per year to $48,000 per year, and leaving behind $90,000 in investments for your survivors instead of $1 million.
Reducing that loss of income to approximately 30 percent during all five years of disability by owning supplemental disability insurance that replaces up to 70 percent of the pre-disability annual income increases the retirement standard of living to $64,200 and the terminal value of the investment portfolio to $546,627. While this is not ideal, since it still represents a significant reduction from what you would have enjoyed had you not been disabled, it is a substantial improvement over the worst case and is about as good as insurance will allow.
These results make two things clear: First, the risk of disability is a serious threat to federal employees that must be considered as part of any prudent financial plan, and second, supplemental disability insurance is something to consider as a way to manage this risk.
After I mentioned disability insurance in a November column, a reader pointed out to me that there are supplemental disability insurance policies designed for federal employees. These policies are generally intended to bring disability income up to some pre-selected level – usually 50, 60 or 70 percent of your pre-disability salary.
Coverage is available from a variety of sources, including individual policies and group coverage through association membership. Using a representative sample for the cost of the insurance, I found that paying for the insurance during your entire career, and never needing it, tended to reduce the expected retirement standard of living by less than 1 percent and the terminal value of the investment portfolio by less than 3 percent across a wide range of age and career-stage scenarios. It is interesting to note, however, that paying the premiums for supplemental insurance had the smallest negative impact on the results for younger employees, even though they will have to pay for the insurance longer than their older colleagues.
The study results indicate that older, later-career employees should also consider the disability risk, although the case for buying insurance is somewhat less compelling. In these cases, as the risk of becoming disabled goes up, its impact on the retirement standard of living goes down. The cost of buying insurance is higher than at younger ages, but the financial impact, overall, is still relatively small. Based on the results, however, I think that many career feds who are at least 50 years old with 25 years of service can probably afford to pass on buying insurance.
Every case is unique, however, and you should base your financial decisions, including the decision to purchase supplemental disability insurance, on thorough, competent analysis, rather than emotion or sales pitches. If you’re interested in looking into disability insurance for feds, you can visit www.fedadvantage.com, www.wright usa.com, www.sambaplans.com, or check with your professional associations to see if they offer coverage as a member benefit.
Written by Mike Miles
For the Federal Times
Publication June 11, 2012