Total Portfolio Approach

Everything You Wanted to Know about Disability Insurance (But Were Afraid to Ask)

May is Disability Awareness Month. While most people know about life insurance, fewer people consider the importance of disability insurance. Here are some noteworthy facts about disability from credible, third-party sources, compliments of Bob Gertie of Advisor Insurance Resource.

Causes of Disability

Many people think of disability as something that only happens to a manual laborer or blue collar worker. But a disability can happen to anyone. Consider these facts:

  • While many people think that disabilities are typically caused by freak accidents, the majority of long-term absences from work are actually due to illnesses, such as cancer and heart disease. (Life and Health Insurance Foundation for Education, November 2005)
  • Stroke is a leading cause of serious long-term disability. (Centers for Disease Control and Prevention, 2007)
  • Common causes of individual disability insurance claims are:
  • Over 85% of disabling accidents and illnesses are not work related, and are therefore not covered by worker’s compensation. (National Safety Council®, Injury Facts® 2008 Ed.) 

Need for Protection

A disability can happen to anyone, at any time.

  • At age 40, the average worker faces only a 14% chance of dying before age 65 but a 21% chance of being disabled for 90 days or more. (Insurance Information Institute, www.iii.org, November 2005)
  • In 2007, 12.8% of people ages 21–64 surveyed had a disabling illness. (U.S. Census Bureau, American Community Survey, 2007)
  • In the U.S., a disabling injury occurs every second, and a fatal injury occurs every 4 minutes. (National Safety Council®, Injury Facts® 2008 Ed.)
  • In the home, a fatal injury occurs every 12 minutes and a disabling injury every three seconds. (National Safety Council®, Injury Facts® 2008 Ed.)
  • There is a death caused by a motor vehicle crash every 12 minutes and there is a disabling injury every 13 seconds. (National Safety Council®, Injury Facts® 2008 Ed.)
  • Almost 3 in 10 workers entering the workforce today will become disabled before retirement. (Social Security Administration, Fact Sheet, January 31, 2007)
  •  In 2007, the employment rate of working-age people with disabilities in the U.S. was 36.9%. (U.S. Census Bureau, American Community Survey, 2007)
  •  Forty-three percent of all 40-year-olds will have a long-term disability event prior to age 65. (JHA Disability Fact Book, 2006)

Disability Duration

The average disability lasts longer than you think.

  • The average duration of a long-term disability is 30 months. (JHA Disability Fact Book, 2006)
  • Nearly 1 in 5 Americans will become disabled for one year or more before the age of 65. (Life and Health Insurance Foundation for Education, November 2005)
  • Three out of 10 workers between the ages of 25 and 65 will experience an accident or illness that keeps them out of work for three months or longer. (Social Security Administration, Fact Sheet, January 31, 2007)

Social Security Misconceptions

People have many misconceptions about the Social Security benefits they may receive if they become disabled. For example:

  •  More than 1 in 5 adults believe that unemployment or Social Security will cover them if they become disabled. (Disability Literacy: How Consumers Rate Today, April 2005, The Hartford)
  • Less than half―39%―of the 2.1 million workers who applied for Social Security Disability Insurance (SSDI) benefits in 2005 were approved. (Social Security Administration, Office of Disability and Income Security Programs)
  • The average monthly SSDI benefit is $1,004. (Social Security Administration, Fact Sheet 2008)
  •  In 2007, the percentage of working-age people with disabilities receiving SSDI payments in the U.S. was 17.1%. (U.S. Census Bureau, American Community Survey, 2007)

The Bottom Line

Disability is a major risk both in terms of probability and financial impact. Social Security is not a viable solution in many cases. Employer plans have limits―and you won’t work for your employer forever. Individual disability insurance coverage is often needed to supplement employer coverage, plus it is portable when you change jobs. Simply compare the cost of disability to life insurance and you can see the probability risk and financial risk of disability. Disability insurance is expensive but important!

About Bruce J. Berno, CFP®

Bruce J. Berno, CFP® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.

A “Total Portfolio Approach” and Why It Is Important

Most investors have more than one investment account. They may have an employer’s 401(k), an IRA rollover, a Roth IRA, a joint taxable account and a college 529 plan. Some accounts, such as retirement accounts, all have the same goal, while other accounts, such as a joint taxable account or a college 529 plan, may have different goals. Cash flows, or deposits or withdrawals, from various accounts may be different too. For those with multiple investment accounts, a “Total Portfolio Approach” will help establish an asset allocation as well as an asset location strategy.

  • Asset allocation influences long-term expected returns and volatility.
  • Asset location influences liquidity and income tax efficiency.

For example, an investor may determine that an asset allocation of 70% stocks, 25% bonds and 5% money market funds is ideal for long-term expected returns and volatility.

Does this mean every account will have the same asset allocation? Maybe not. First, the employer 401(k) plan may have a Stable Value Fund, which is attractive but not available in the other accounts. The 401(k) plan may not have a good U.S. small company fund or international fund choice. The Roth IRA may be the last asset to tap into and possibly leave as an inheritance, so more aggressive investments may be appropriate. An investor may need a large cash balance in the joint account to pay for a lump-sum expense within the next year, such as a new car or wedding. The beneficiary of the college 529 plan may be in high school now and the investor doesn’t want to risk a 20% drop in the stock market when the student is a senior in high school.

Implementing the target asset allocation in this case may mean:

  • A higher allocation to bonds in the 401(k) to take advantage of the Stable Value Fund
  • A larger allocation to stocks in the rollover IRA, including U.S. small company or international funds that are better than the 401(k) choices
  • A more aggressive long-term Roth IRA strategy that is more than 75% in stocks
  • More than 5% cash in the joint account to cover the new car or wedding
  • A higher bond or cash allocation in the college 529 plan to minimize stock market risk

Using this asset location strategy will improve liquidity because there will be more money market funds in the joint account and college 529 plan, and it will be possible to withdraw from these for short-term needs.

Asset location can also optimize tax efficiency by having high-income or tax-inefficient investments (such as real estate, commodity or inflation-protected bond funds) in a tax-deferred account such as the IRA rollover or Roth IRA.

Investors should focus on what they can control. Investors cannot control the short-term direction of the stock market or interest rates, but they can control their asset allocation and asset location. A Total Portfolio Approach increases the likelihood that an investor will achieve their personal financial planning goals.

 

About Bruce J. Berno, CFP®

Bruce J. Berno, CFP® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.