Your High-Income Is An Asset. What is the Value and is it Protected?
The Real Value of Income
“What is your biggest financial asset?” Many working individuals will respond with: house, car, or maybe a retirement account. Unfortunately, many overlook the ability to produce an income and the future value of this asset. Much of this disconnect is not only because income is not a physical asset, but also by not thinking about income in the right way—as a future earnings stream or human capital. Many people think about their income in terms of their pay frequency or as their annual salary (and incentive pay). While there are no guarantees, for many, incomes are likely to increase over time due to more experience and education.
The younger the person + the more potential future working years = higher potential future value.
The Problem – Is Income Properly Protected?
High-Income professionals often overlook the need to protect their earning potential compared to other assets and liabilities. Future earnings are a substantial asset. A shortened or interrupted career may require a major lifestyle change (reduction) which may further may impact long-term financial goals by delaying them or not reaching them at all. Being unable to work during the accumulation phase of life is essentially another form of a sequence of returns risk, but you are the portfolio.
Professionals also may not have a good understanding of their current income protection levels. For example, one may believe their employer provided disability benefits provides 60% income replacement through a group long-term disability (LTD) plan. However, most will not realize there are gaps caused by lack of coverage for incentive compensation, limits on benefit amounts provided, and taxes on those benefits at claim time! Individually or combined this will result in much less than expected (and lifestyle needs) in the event of a claim.
A Visual Look at Future Income and Disability Coverage
The amount of potential future income is often eye opening! Creating a future income projection is simple enough, but it is important to determine how much of that income is covered with disability insurance in the event of an illness or accident. Then match up with your current income to determine the gap today.
Take the example of an executive below earning $600,000 annually at Age 55. This assumes a group LTD benefit of 60% to $15,000 per month.
Even with a healthy group LTD benefit of $15,000 per month in this situation, there is still a huge gap in income protection. Ignoring taxes, this is only 30% income replacement! Since earnings are expected to continue growing, it is important to periodically review, as often this growth will not be linear. A best practice would be to review coverage every 1-2 years, but especially after job changes, income adjustments, and other life events to ensure coverage is still meeting financial protection goals.
How to Close the Gap?
A variety of sources of income protection to provide coverage for long-term disabilities is available. The most common options include:
- Group Long-Term Disability (LTD)—Coverage may provided by or made available through an employer. Benefits will vary greatly employer to employer so check with Human Resources for a benefit summary or certificate of coverage to learn more about the plan.
- Individual Disability Insurance (IDI)—Coverage may be obtained in multiple ways: on your own, through an association, or through an employer.
> On your own working through an insurance broker for a fully customized plan and will require the most underwriting and premium.
> An association will provide a small discount and possibly some underwriting concessions, but plan design may fall within distinct parameters.
> Access to an employer-sponsored plan allows for the easiest underwriting and largest discounts. The plan design will be pre-selected at the employer-level, but will supplement with underlying group LTD coverage.
- Excess Disability—For very high-income professionals (or non-traditional/unique occupations) additional coverage may be needed when traditional products (LTD and/or IDI) are unavailable or cannot provide enough benefit. The most common policies are from the Lloyd’s of London market also obtained through an insurance broker.
- Social Security Disability Income (SSDI)—Not to be overlooked this may provide some benefits, but will have a more strict definition to qualify for benefits compared to private policies in most cases. Group LTD will offset with SSDI benefits, but may also provide resources to help navigate the process to seek claim approval.