Most people don’t even think about disability.  It’s sort of the ninja of personal finance.  It silently hurts you.  The reason I say this is because there is no announcement in the newspaper and there are no big events held.  Something bad happens and you end up in near seclusion as you try to recover.  Usually the only people that are around to help and support you are your family and friends.  Unless you are one of those people you never realize what someone has to deal with when they become disabled.

Maybe you are one of the lucky one’s that has group disability coverage through work.  You really, truly want to believe that your coverage will be there to help you if something were to happen.  Well here’s 7 ways that group disability coverage will fail you.

1. It covers 60% of your income. Most group disability insurance covers up to 60% of your income.  Can you live with that big of a pay cut?  Don’t forget to add on the extra medical bills from the accident that caused the disability.  Then there are the medical bills from the rehabilitation.  Well we can ignore those for now.  Make a list of your five biggest bills (mortgage, car payment, taxes, etc.).  Now which two aren’t you going to pay?
2. You’re employer is nice enough to pay for it. Isn’t that nice of your employer to pay for your group disability insurance?  I would think so too at first.  From an IRS standpoint though, if your employer pays for the coverage that means you don’t pay taxes on that money.  Now if you were to become disabled, since there were not taxes paid yet, the benefits are now taxable.  This means that if you are in a 15% effective tax rate, then your 60% coverage just got cut down to about 50%.
3. You make bonuses and/or commissions. There are a lot of people out there who have a large part of their income tied to bonuses and/or commissions.  Did you know that most group disability insurance doesn’t cover these at all?  Usually they only cover base salary.  This means that if you have a $100,000 base salary plus an extra $50,000 through bonuses and/or commissions, then when you factor in #1 & #2 above you are now down to about 33% coverage.  The pay cut just keeps getting bigger.
4. There is also a cap. Most group coverage will cap your monthly coverage amount.  The most common cap is between $5,000-$6,000 per month.  To give you an idea, each $1,000 of month coverage, covers $20,000 of salary at 60%.  So a $5,000 cap will cover the first $100,000 and a $6,000 cap will cover the first $120,000.  If you make more than that, you are taking an even bigger pay cut.
5. There is a social security offset. Most group disability insurance will offset your benefit by the amount you receive from social security.  If you’ve been reading this thinking that you’ll have some extra money on top of your disability benefit, don’t count on it.  Some companies won’t even pay you the social security portion until your coverage has been denied by social security (which will most likely happen when you apply anyways).
6. You can go work somewhere else. With disability insurance there is a feature called own-occupation.  This means that you are unable to perform the duties of your specific occupation even if you are able to work in an other occupation.  Good group disability coverage will cover your own-occupation for a period of 2 years after that if you can work anywhere (yes, even McDonald’s) then you receive no more benefits.  Notice I said ‘good’ coverage, a lot of policies don’t even have the own-occupation benefit.
7. You can’t contribute to your 401k when you aren’t working. No one ever thinks of this.  If you are not working you cannot contribute to your company 401k.  I have yet to see any type of group coverage that will account or help with this in any way.  Most individual disability insurance policies will have a rider or stand alone feature that will continue to contribute to your retirement for you if you were to become disable (yes, this costs extra).

If you ever get a financial plan done it should include an analysis of your disability coverage.  A lot of times and individual disability insurance policy is needed to supplement your group coverage in order to provide adequate protection for you and your loves ones.  If you are unsure about your coverage you should consult a financial professional or get an insurance assessment.

Related posts:

1. 5 More Ways Group Disability Insurance Disappoints
2. Pricing Your Disability Insurance
3. 7 Disability Insurance Add-on Features

I was going through my e-mails the other day when I received another e-mail from an insurance company (I say that because I receive a lot of e-mails from various insurance companies) advertising some change in their current offerings.  I breezed over it when something jumped out at me.  The thing that really caught my eye on this e-mail was that it was advertising a rate increase.  The current economic environment isn’t leading to very many rate increases.  It seems like nowadays all I’m seeing is rate decreases, so it was refreshing to see an increase.

This got my attention so I read on. The e-mail was promoting an immediate annuity.  The big hook that the e-mail had was that a 65 year old male could get 7.2% income from this particular immediate annuity.  In a world of the 4% rule this caught my attention.    What this company is saying is that $100,000 could be turned into approximately $7,200 per year for as long as you live.

I’m not someone that says everyone needs an annuity but it does give you some advantages:

• Guaranteed stream of income – The company that sent me the e-mail has a Comdex of 98 which means that they are financially rated in the top 2% of all insurance companies.  That’s a pretty strong guarantee.
• No down years - One of the biggest killers of retirement withdrawals is years like 2008.  When you withdraw money during a down year, your accounts will never be able to recover.  You are not depending on the market.
• Diversification – Everyone talks about it.  People talk about diversifying your streams of income.  Here is a great way to do that.
• Leave something behind – This is probably the second biggest argument against annuitization.  I looked into it closer and a 65 year-old male in average health can guarantee an insurance policy for the $100,000 he just annuitized for about $2,000 per year.  This means that he would still be receiving 5% income guaranteed for the rest of his life.
• Control – The number one reason against annuitization is that you are giving up control of your money.  This is true.  So don’t annuitize all your money.  You only want to annuitize a portion of your money.  Usually this will be a portion that will cover fixed expenses that you know are going to be there.  Bills such as property taxes, insurance, utilities; these are bills that are always going to be there regards less.  If you’re not sure where your money goes I recommend using personal finance software to help track your spending.

What about inflation?

I have not mentioned inflation.  I know what you are thinking the 4% rule is indexed for inflation.  Well the advertisement they sent me never even mentions inflation.  I would be willing to bet money that some stupid people that call themselves financial advisers are going to go out and try to sell 7.2% income and never even thought about inflation.  It’s the first thing I thought about so I went into my software and started to dig around quickly.  When indexed for a 2% inflation the payout was about 6%.  But this is where your other assets come into  play.  Here is where your investments would be used to hedge against inflation.  Diversification is key.  There’s no perfect fix.  Your investments would be part of your income rather than all of it.

Related posts:

1. RMA: Income Planning Program

How do you determine the financial strength of an insurance company?

The problem arises when you go looking for a companies financial strength.  Where do you start?  There are 4 main rating companies:

1. A.M. Best
2. Standard & Poor’s
3. Moody’s
4. Fitch

Rating services do not use a universal scale.

S&P and Fitch are the most closely related both using a similar scale (AAA, AA, A, BBB, BB, B, etc).  They both use + and – as modifiers within their scale as well.  Moody’s on the other hand uses a fairly similar scale (Aaa, Aa, A, Baa, Ba, B, etc) but their modifiers are numeric with 1 being on the high end to 3 being on the low end.  AM Best focuses a bit more on the + and – with their scale (A++, A+, A, A-, B++, B+, B, B-, etc).  To access most of the sites and usually their rating scales or definitions you’ll also need to sign up.  Yes, it’s free to do so but it’s just one more tedious step for someone doing the proper research.

There is a problem of crossover.

You look up your life insurance company or your disability insurance company and they are an A+.  What does that mean?  Well with AM Best it’s the second best rating you can get.  That’s a superior rating.  But if it’s S&P or Fitch it’s the fifth best rating you can get.  With Moody’s that would probably be equivalent to an A1 rating.  Of course it could be a problem if you mistook the superior rating of AM Best with the upper medium rating of Moody’s or the ‘credit may affect finance’ rating (that doesn’t sound too good) of S&P or Fitch.

To make matters worse, when you go online for an insurance quote they often won’t show you all the ratings.  They might show you one or two and it’s up to you to understand what the rating is and put it in perspective.  Insurance agents are notorious for this too.  They will only show you the top rating.  It is not unusual for life insurance company’s ratings to vary quite a bit from agency to agency.

Enter Comdex

The Comdex is not a rating system but is instead a composite of the ratings a company has received.  The key here is that instead of focusing on the letter that is assigned to companies, Ebix Inc. focuses on the number or percentage of companies receiving each letter.  They then correlate this into a percentile score on a scale from 1 to 100.  The Comdex becomes a composite index that gives a company’s standing in relation to other companies that have been rated.  It gives a universal scale on which to compare your life insurance and disability insurance providers.

I am unaware of any free or easy way that the public can access the Comdex system.  But what you can do, is look up individual companies.  Almost all insurance providers have information pertaining to their financial strength easily accessible on their websites, this will usually include a Comdex score.  You can also request this information for your financial professional that you are working with.  I have full access to the Comdex database.  If you would like to learn more about a specific insurance company or how that company compares to other companies just ask and I will be happy to share that information with you.

To give you an example of how financial strengths might compare:

Related posts:

1. Banks vs Insurance Companies
2. Hidden Gem of Life Insurance Policies
3. How is Life Insurance Underwritten?

Four years ago a woman named “Jane” had a problem.  She was receiving payments as part of a buyout from her husband’s business.  Her dilemma was how to replace the payments she was receiving while also trying to pass as much on to her kids as possible.  She was proud of her husband and the business that he created and passed on to their kids.  With all the hard work over the years if she wasn’t going to spend the money she wanted to make sure her family got as much as possible.

[As a side note she does have other assets and other income we are going to focus on one account for now]

Jane was about to turn 76.  The total sum of money that she had available was $300,000.  Her current accounts were $100,000 in a fixed annuity earning around 3.5% with Ameriprise, $120,000 in a few different CDs that were earning 3-4% and $80,000 in some mutual funds that an adviser had put together for her.  Are you with me so far?

What She Did

She put the full $300,000 into an AXA Equitable Accumulator, a variable annuity.  Then she added a couple of riders to her contract.  First she added a GMIB rider and then a death benefit rider.  We’ll get to those in a second.

Fees

That’s what everyone is thinking about and wondering about so let’s start there.  It is an annuity.  The basic contract has mortality and expenses associated with it totaling 1.25% per year.  The GMIB rider has an expense of 0.65% and the death benefit that she chose has an expense of 0.60%.  Getting expensive and we haven’t even added in the investments.  The investment expenses range from 0.64% to 3.65%.  Jane’s current portfolio is costing her 1.08%.  This brings the total charges on her contract to 3.58%.

Death Benefit Rider

The death benefit rider that Jane chose was the greater of 6% roll-up or annual ratchet to age 85.  During the first couple of years of the contract she was enjoying the annual ratchet.  With the lock-in in 2007 she was left with a death benefit of $380,000.  This meant that in 2008 when the market was falling, Jane’s death benefit on this contract was $380,000.  It was not subject to investment fluctuations.

Guaranteed Minimum Income Benefit

The GMIB rider that Jane chose gave her a base benefit that would roll-up by 6% per year.  She is required to hold the contract for 10 years after which point if she chooses she could annuitize off of the benefit amount regardless of her contract value.  For Jane this meant that she would start at $300,000.  She will earn 6% net of fees for her benefit amount.  So in the first year she would earn 6% of $300,000 or $18,000.  In the second year she will earn 6% of $318,000 or $19,080.  And so on.  Are you still with me?

Income

As we mentioned at the beginning Jane was going to be needing income in 2 years.  What this meant was that her account was allowed to do nothing but grow for the first two years.  In fact, with the market performance of 2006 and 2007 she found herself with a contract value of $380,000 and her benefit amount was $337,080.  Who needs this stinking safety net?  But now Jane needed income.  The way her GMIB works is that it allows her to take up to the 6% roll-up on her benefit on a dollar-for-dollar basis.  This meant that if she takes the 6% as income her benefit amount stays flat.  So this is what she did.  She took the 6% in the third contract year as monthly income and it came out to approximately $1,685 per month.

Taxes

Keep in mind that Jane had gains in this variable annuity due to market performance.  This was a non-qualified annuity which meant that the gains were taxable as ordinary income.  Annuities also follow LIFO which stand for last in, first out.  This means that all the gains come out before the contributions.  So when she began taking income in 2008 it was fully taxable and subject to a 20% withholding.  The checks she received then were for approximately $1,350.

2008 Market

Then 2008 hit.  The markets started to crash and they crashed fast.  Now because of her safety net, Jane chose to be a little bit more aggressive with this account.  She was actually in about a 65/35 splits towards equities.  The funny thing is today she has the same 65/35 split.  Her account is set to rebalance quarterly.  She just might need the safety net now.  Are the costs still too high?  The upside is that now she no longer has to worry about the taxability of her income since the gains in the account went away pretty quickly in 2008.

Today

Today she continues to receive her income of $1,685 per month.  Her account value is $255,000.  She started with $300,000 and has withdrawn about $40,000.  So it looks like she’s almost even.  Then we look at her benefit amount and it is $337,080.  Her death benefit was up to $380,000 using the ratchet feature but it has been reduced by the income she has received so today it is $340,000.  Remember that as she continues to take income this death benefit cannot fall below her contract benefit amount (the 6% roll-up).  One thing not to forget is that she can’t access that benefit amount until one of three things happens: 1. she passes away, 2. her account value drops to zero and 3. her 10th contract year (age 85).  This means she continues to receive her $1,685 per month until age 85 at which point she can then annuitize off the benefit amount which the contract estimates to provide $40,000 per year.  Not a bad pay raise.

What do you think?  Good deal?

**Disclaimer:  This is based on a true story.  Names have been changed and numbers adjusted slightly to make them more easier to work with.  All contract information was taken from the prospectus.  This contract is no longer offered.**

Related posts:

1. What Is Your Greatest Asset?

There seems to be a competition heating up.  It’s always been there.  The battle of the CD versus the fixed annuity.  Now most of you probably don’t see this as a battle.  Most people don’t see this as a competition.  Do you think the bans want fixed annuity money?  You bet.  Do you think the insurance companies want CD money?  Definitely.

So I consider it a competition.

Short-Term vs Long-Term

The deciding factor here is you.  Short term and long-term are relative terms.  Usually short-term is less than 5 years and long-term is longer.  This might be different for your personal situation but we’re going to use this guideline today.  CDs would then be a short-term investment.  I would guess that most people use CDs for 18 months or less.  They do however have terms that extend out to 5 years maybe even further.  Annuities tend to be used in the 5 to 7 year range.  Some companies do offer them for as short a term as 1 year but this is rare in today’s environment.  So you might be asking where the competition is?

Have you heard of the hybrid CD?

BusinessWeek has an article titled Investing: Should You Test-Drive a Hybrid CD? Banks are now starting to introduce equity-linked certificates of deposits.  The main driving force for this is that rates are just so low on CDs.  How do you beef up rates?  Apparently you tie them to the S&P 500 and hope for the best.  In order to make this work banks will need to use longer term CDs.  Mentioned in the article are between 3 and 5 years.  The article talks about interest caps as low as 3% with surrender charges as high as 9%.  Isn’t this the outrage over Equity Indexed Annuities?

The Industries

It looks like it is going to be a bit of a competition.  As a consumer you get to weigh your options.  The banking industry or the insurance company.  The CDs are FDIC insured, the annuity has a lot higher reserve requirements and a state guarantee fund.  The commission of the insurance agents going against the bailout of the banking industry.  Do you think either will try to educate you on your decisions or just try and sell you something?

From the early information I’ve seen, the same problems with EIAs will apply to the hybrid CDs: high surrender charges with low and confusing crediting rates.  The one thing the bank will hide is commissions.  Since they don’t have the traditional sales force of an insurance company the consumer won’t see whose getting paid or be clear on how much they are getting paid.  Don’t be confused though, the banks will stand to make plenty of money on these hybrid CDs.  If you have a 3% cap or a 20% participation rate guess who keeps the extra money?

There might be another dilemma.  An independent insurance agent or financial planner should technically be shopping around to find the best EIA product for the client since commission have become so similar.  These could theoretically mean that the consumers are getting more of the better EIAs since they all aren’t created equal.  What happens in a bank?  There is no independent bankers to do the work for you.  It is up to the consumer to do their homework and comparison.  The consumer will have to understand the different crediting rates, caps and surrender charges and how they vary from bank to bank.  If they just go into ABC Bank all that they will be told about is ABC Bank’s CDs.

Would you rather support a salesman trying to make a living or the infamous banking industry? That’s quite the coin flip.  Call it in the air…

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Related posts:

1. Financial Strength of Insurance Companies
2. Hidden Gem of Life Insurance Policies
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Have you ever been asked that question?  How did you answer it?  Most people look for something concrete.  They need something they can see, touch and feel.  They might have a big investment account or a business they own but for most people they say their house.  The more money people have the bigger the house.  The bigger the house the bigger the asset.  So it makes sense to think that.

How are you able to have such a great house?

This is where they start thinking.  Maybe an investment paid off and that comes up or they bring up that business again.  Most people just have a good job that they like.  Oh a job or business, what does that depend on?  I always get blank stares if I ask this question.

What does your job or your business depend on?

They depend on you.  Without you and your ability to work hard they wouldn’t exist.  I mean isn’t this true?  With the abilities, education and experience that you have you were able to earn an income.  Usually, the better the skills the better the income.  So what to all your assets mentioned so far if you were unable to earn this income?

Do you have disability insurance?

Disability insurance protects your greatest asset, your ability to earn an income.  If you are unable to work due to illness or injury a good disability insurance policy will step in and replace a large portion of your income.  If you run a business this policy could keep the business running either by covering the expense or by freeing up money to compensate for the lack of an executive.

I’m covered through work.

I hear this all the time and you probably do have some coverage through work.  A lot of employers are nice enough to even pay for this coverage.  The problem is that people don’t understand the coverage they have through work.  They skim the over their options and see 60% coverage and say great.  What they don’t realize is they usually have closer to 40% coverage through work.  The problem is that most group coverages don’t cover bonuses or commissions.  They also usually have tax consequences.  What do you make a year?  Could you live off of 40% of that?  A better question might be, would you want to?

Follow my feed, follow me on twitter and e-mail me.

Related posts:

1. When a Variable Annuity Can Work
2. Pricing Your Disability Insurance
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