Picture this: You have a client – 10 years away from retirement – who comes to you for retirement advice. You spend several hours, maybe a full day with him, going over many different retirement scenarios.
At the end of this exercise, you prepare a plan that is as thick as a phone book. In your next meeting, you review it with him. One of your suggestions is that he buy disability (a.k.a. income replacement) insurance, in case he becomes unable to work and earn income.
Your client says the company he works for already gives him a similar insurance and that he is not at all interested in purchasing his own disability insurance. After some intense discussions, you fail to convince him. “Oh well” you say to yourself, “maybe he’ll come around soon.”
The client may have reasons for not being keen on disability insurance. Perhaps he’s opposed to it for some reason. Perhaps he thinks you’re going to make a high commission off it. Perhaps he genuinely believes his company hired him for life and the plan it offers is good enough.
It doesn’t matter. The bottom line is: you haven’t been able to show him that disability insurance is an essential part of his overall retirement plan.
What is your best selling point? Illustrate the impact of loss of income to his retirement.
A tale of three trajectories
Let’s look at one married couple’s situation: Bob and Sue, both 55, who have about $300,000 in their retirement accounts. Their asset allocation is 40% equities and 60% fixed income. They are planning to save $25,000 (combined) annually and aim to retire in ten years, at age 65.
After retirement, they figure they need $50,000 annually – in current dollars – indexed to inflation. They expect a total of $25,000 from their Canada Pension Plan and Old Age Security benefits. They want to plan for income until age 95, a thirty-year withdrawal time horizon.
Running this information through a retirement calculator, based on actual market history, shows they have a good plan. If they’re lucky (top decile of all historical outcomes) and catch a good, long-term market trend, they’ll have about $2.7 million in their portfolio at age 95.
If they’re unlucky (bottom decile of all historical outcomes) they’ll have about $250,000 at age 95.
While this sounds great, there are caveats. What if Bob loses his job? In that case, he also loses his disability insurance coverage. Now, he is on his own. What if he experiences a health problem or an accident and is unable to earn income for a while?
Now, the couple can no longer save the $25,000 they were hoping to annually. Worse, Bob may have to withdraw money from their retirement savings just to make ends meet. Their meticulously planned retirement finances go down the drain.
The green line on the graph indicates the portfolio value if Bob has no disability insurance and no disability occurs. In this scenario, Bob earns income continuously until age 65. Everything looks great; the couple’s portfolio lasts at least until age 95.
The maroon line depicts the portfolio value if Bob has no disability coverage and becomes disabled during ages 55 and 56. In this case, the portfolio life is reduced by seven years. If Bob were single, that might be OK, because a disability lasting two years might also reduce his life expectancy. But he has a spouse and there is a 36% chance that Sue would still be alive when the money runs out at age 88. Not an acceptable retirement plan.
The mustard line indicates the portfolio value if Bob is unable to earn income at ages 55 and 56 but has disability insurance. The portfolio value is slightly lower than the green line because of the cost of the disability insurance. But Bob and Sue still have income until age 95. This is a retirement plan that makes sense.
There are many factors that affect the reduction of portfolio life, such as how many excess assets a person might have in the portfolio, how much each spouse earns, the timing of disability relative to retirement age, the total cost of additional expenses, and whether or not one is eligible for CPP disability pension.